On the Epidemic of Financial Crises


Speaker


Abstract

A financial crisis originating in one country can travel within and beyond its original neighbourhood spreading among countries like a contagious disease. This paper proposes a framework for modelling financial contagion that is based on SIR (Susceptible-Infected-Recovered) transmission models from epidemic theory. It addresses two important features of contagion modelling which are a common shortcoming of most existing empirical approaches, namely the direct modelling of the inherent dependencies involved in the transmission mechanism, and an associated canonical measure of crisis severity. The proposed methodology naturally implies a control mechanism, which is required when evaluating prospective immunisation policies that intend to mitigate the impact of a crisis. It can be implemented not only ex-post, as a way of learning from past experiences, but also at the onset of a contagious financial crisis. The approach is illustrated using both historical final outcome and temporal data on a number of currency crisis episodes. The latter requires the introduction of a novel hierarchical model, termed the Hidden Epidemic Model (HEM), which embeds the stochastic financial epidemic as a latent process. The empirical results suggest an increasing trend for global transmission of currency crises over time.
 
Contact information:
Michel van de Velden                 Kees Bouwman
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