The Contagion Box: Measuring Financial Market Co-movements by Regression Quantiles

This paper develops an econometric framework to investigate the structure of codependences across markets and to test whether it changes over time or across market conditions. Our approach is based on the computation, over both a test and a benchmark period, of the conditional probability that the returns on one market are lower than a given quantile, when returns on the other market are also lower than their corresponding quantile, for any set of prespeci…ed quantiles. Quantiles are allowed to vary over time using the CAViaR methodology developed by Engle and Manganelli (2004). Graphically, the conditional probabilities can be represented in what we call “the contagion box”, which is a square of unit side. Since a 45 line represents the case of independence, the presence of comovements is indicated when the conditional probability plots above this line. Di¤erences in the intensity of co-movements can be identi…ed directly from the conditional probability plots for test and benchmark periods. From this insight, rigorous econometric tests of contagion are derived and implemented. In the process we obtain a new result in the regression quantile literature. We illustrate the methodology by investigating the impact of the “tequila” (1994/95), Asian (1997) and Russian (1998) crises on the major Latin American equity markets. Our results suggest signi…cant presence of contagion. Preliminary and incomplete. Comments welcome. yCappiello and Manganelli are with DG-Research at the European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany. Email: [email protected], tel: +49-69 1344 8765 and [email protected], tel: +49-69 1344 7347. Gerard is with the department of Finance and CentER, Tilburg University, and with the Norwegian School of Management BI, Elias Smiths vei 18, Box 580 N-1302 Sandvika, Norway. Email: [email protected], tel: +47-67 55 71 05. We are indebted to Matteo Ciccarelli, Philipp Hartmann, as well as workshop participants at European Central Bank, 2004 Latin American Meeting of the Econometric Society (Santiago, Chile), Tilburg University, University of Michigan and Caltech for their valuable comments and discussions. The views expressed in this paper are those of the authors and do not necessarily re‡ect those of the European Central Bank or the Eurosystem.