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Full Description
Researchers, policymakers and commentators have long debated the patterns through which adverse shocks in a few markets may quickly spread to a range of apparently disconnected financial markets causing widespread losses and turmoil.
This book uses modern linear and non-linear econometric methods to characterize how shocks to the yield of risky fixed income securities, such as sub-prime asset-backed or low-credit rating sovereign bonds, are transmitted to the yields in other markets. These include equity and corporate bond markets as well as relatively risk-free fixed income securities, such as highly rated asset-backed securities and sovereign bonds from core Eurozone countries. The authors analyse and compare the results from linear and non-linear models to identify and assess four distinct contagion channels characterizing both US and European financial markets. These include the correlated information, risk premium, flight-to-liquidity, and flight-to quality channels. The results of this study support the theory that both investors and policy-makers ought to pay special attention to liquidity and commonalities in the perceptions of the probabilities of default, as channels through which financial shocks propagate.
Contents
Preface 1. The background: channels of contagion in the US financial crisis 1.1. A brief review of the sequence of events during the US financial crisis 1.2. Modeling alternative cross-market contagion channels 2. Methodology 2.1. Vector autoregressive models 2.1.1. Reduced vs. structural forms 2.1.2. Estimation 2.1.3. Impulse response functions 2.2. Markov switching vector autoregressive models 2.2.1. The model 2.2.2. Estimation 2.2.3. Generalized impulse response functions for MS models 3. The data 3.1. Asset-backed securities 3.2. The Treasury repo and Treasury bond markets 3.3. Corporate bonds 3.4. The equity market 3.5. Summary statistics 4. Estimates of single-state VAR models 4.1. Model selection 4.2. The VAR(2) model 5. Results from Markov switching models 5.1. Model selection 5.2. A three-regime MSVAR model 5.2.1. Economic interpretation of the regimes 6. Estimating and disentangling the contagion channels 6.1. A methodology to identify contagion channels 6.2. Overall patterns of financial contagion 6.3. The liquidity channel 6.4. The risk premium and the flight-to-quality channel 6.5. The correlated information channel 7. Comparing the US and European contagion experiences 7.1. A European data set 7.2. Alternative channels of contagion in the European sovereign crisis 7.3. Cross-country, cross-market shocks: did the subprime crisis spill over to Europe? 8. Conclusions References Index
