Measuring financial contagion: Dealing with the volatility Bias in the correlation dynamics

Christopher Michael Starkey and Georges Tsafack

International Review of Financial Analysis, 2023, vol. 90, issue C

Abstract: Most economist agree that contagion is a change in the dependence structure during bad times in international financial markets, however measuring and testing this change remains a challenging issue. Correlation is often used to assess contagion but suffers a volatility bias. Forbes and Rigobon (2002) propose a correction to this bias based on a strong assumption of constant beta. We find that this assumption is not supported by data. We then suggest the rank correlation as an alternative measure which not only is robust to volatility bias but is free of assumption, making it more appropriate than many of the methods used to study contagion. Using that measure, we test for contagion in a large number of financial crises and find contagion in most cases.

Keywords: Contagion; Volatility bias; Rank correlation (search for similar items in EconPapers)
JEL-codes: C10 G15 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:90:y:2023:i:c:s1057521923003794

DOI: 10.1016/j.irfa.2023.102863

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