Wavelet analysis of financial contagion

Research output: Contribution to conferenceOtherpeer-review

Abstract

The aim is to estimate a factor model fitted to financial returns to disentagle the role played by common shock and idiosincratic shocks in shapingthe comovement between asset returns during periods of calm and financial turbulence. For this purpose, we use wavelet analysis and, in particular,the Maximum Overlapping Discrete Wavelet Transform, to decompose the covariance matrix of the asset returns on a scale by scale basis, whereeach scale is associated to a given frequency range. This decomposition will give enough moment conditions to identify the role played by commonand idiosincratic shocks. A Montecarlo simulation experiment shows that our testing methodology has good size and power properties to test forthe null of no contagion (that is, of absence of an increasing role of idiosincratic shocks during turmoil). Finally, using Full Information MaximumLikelihood, we fit our model to test first for the presence of contagion whithin the East Asian region stock msarkets during the 1997-1998 periodof financial turbulence, and, then, whether there is contagion from an index of financial distress in the US to East Asia during the recent sub-primecrisis.
Original languageEnglish
Number of pages35
Publication statusPublished - 2011

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