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Asset price volatility and financial contagion: analysis using the MS-VAR framework


This paper investigates volatility linkages and financial contagion via the asset price channel from the US and Europe to East Asia during the 2007–2011 global financial crisis. Following crisis contingent theories, financial contagion is modeled as the structural change in transmission mechanism after a shock in one country (shift-contagion). Using Markov-switching vector autoregression and multivariate unconditional correlation tests, this study not only addresses the theoretical assumptions about multiple equilibria and nonlinear linkages, but also handles the problems of heteroskedasticity, endogeneity, simultaneous equations and sample selection bias. The empirical results show a significant nonlinear dynamic behaviour of asset returns and volatility interactions across-countries. The volatility spillovers from the US and Europe to East Asian financial markets were mainly caused by fundamental links, apart from in Thailand, which experienced shift-contagion caused by investor behaviours. There is also evidence of the intensified intra-regional linkages in the event of an external shock.

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  1. See Artikis and Nifora (2011) and Lian et al. (2011) for the possible effects of financial crises on industries and firms.

  2. The East Asian countries examined in this study are Hong Kong (HK), Singapore (SG), Korea (KR), Malaysia (ML), Indonesia (ID), Philippines (PH) and Thailand (TL).

  3. Determining number of regimes basing on hypothesis testing is problematic since it fails to satisfy the usual regularity conditions arising from unidentified parameters (Hamilton 2008). On the other hand, state selection procedures using complexity-penalised likelihood criteria (AIC, BIC or HCQ) are subject to poor performance under small sample size and parameter changes, constant autoregressive coefficients and when the Markov chain is not persistent (Psaradakis and Spagnolo 2003).

  4. King and Wadhwani (1990) argue that changes in asset price correlations across markets are driven primarily by unobservable variables. This is consistent with the concept of shift-contagion as well as investor-based contagion.

  5. According to Wang and Moore (2012), the US 5- and 7-year CDS spreads have nearly perfect correlations (0.998) over the crisis period from December 2007 to November 2009. Therefore, the difference in degree of shock transmission of either 5- or 7-year CDS spreads would be very marginal.


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Correspondence to Chau Le.

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Le, C., David, D. Asset price volatility and financial contagion: analysis using the MS-VAR framework. Eurasian Econ Rev 4, 133–162 (2014).

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  • Financial crisis
  • Financial contagion
  • Asset pricing
  • Volatility linkages

JEL Classification

  • G01
  • G02
  • G12
  • G13