Modelling contagion of financial crises

Weihong Huang and Zhenxi Chen

The North American Journal of Economics and Finance, 2020, vol. 54, issue C

Abstract: Inspired by the empirical findings, we include international traders to capture linkage between markets and propose a two-market heterogeneous agents model to simulate financial crisis with contagion effect. This paper manages to calibrate sudden crash behavior of US and UK stock markets during “Black Monday” of 1987 besides smooth crisis and disturbing crisis categorized in literature. It is implied that financial crisis and its contagion could be endogenous, which supports a scenario of over-valuation causing a financial crisis. In addition, the model shows that financial system could be fragile in which small shock(s) hitting individual market’s fundamental could cause financial crisis spreading to the other market. This also supports a scenario of external shock triggering a financial crisis. Lastly, to demonstrate the relevance of our model to financial markets, we manage to match typical stylized facts, especially cross-correlation which is exclusive to a multiple-market case.

Keywords: Financial crash; Contagion; Heterogeneous agents (search for similar items in EconPapers)
JEL-codes: C61 D84 G15 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:54:y:2020:i:c:s106294081830069x

DOI: 10.1016/j.najef.2018.06.007

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