Title: Cross-asset contagion in the financial crisis: A Bayesian time-varying parameter approach
Authors: Manuela Pedio - Bocconi University (Italy) [presenting]
Erwin Hansen - Universidad de Chile (Chile)
Massimo Guidolin - Bocconi University (Italy)
Abstract: Contagion mechanisms in the US financial markets are studied. The recent US subprime crisis provides us with one exogenous shock in a specific market (mortgage-backed securities) to measure contagion. We model the dynamic linkages among markets and allow for changes in this relationship to capture contagion. We look at how and to what extent a negative shock that initially occurred in the asset-backed security (ABS) low-quality market propagated to ABS higher grade, Treasury repos, Treasury note, corporate bond, and stock markets. We rely on dynamic time series models estimated with Bayesian methods. We estimate several specifications ranging from single-state vector autoregressive (VAR) models with constant parameters to fully flexible VAR models where the parameters may vary at each observation. We provide evidence of structural changes in the cross-asset relationships and therefore of contagion. Moreover, by observing the impulse response functions of the models, we conclude that contagion mainly occurred through the flight-to-liquidity, risk premium, and correlated information channels.