Asymmetric Dynamic Conditional Correlation Approach to Financial Contagion: A Study of Asian Markets

Abstract

The study seeks to examine the contagion effect of the global financial crisis on the major Asian markets, namely, China, Hong Kong, Indonesia, South Korea, Malaysia, Japan, India and Taiwan. The study incorporates the impact of leverage effect in the dynamic conditional correlation generalized autoregressive conditional heteroskedasticity (DCC-GARCH) framework to achieve the goal. The US is taken as the crisis-originating country. The period of study has been divided into three categories, namely, pre-crisis period, crisis period and post-crisis period, to examine the sudden change in average conditional correlation from one period to other period so as to identify the contagion effect. The findings support the contagion effect from US market to the major Asian markets with the exception of Japan. Policy makers seek to study the existence of contagion among markets so that they can strategically manage risk and it further helps in asset allocation. If the markets are contagious, then the investors will be unable to reap benefits through international diversification of portfolio. In such a case, the policy makers will further frame policies so that they can insulate themselves from inflicting heavy damage from various crises.