Emerging Markets Contagion: Evidence and Theory

68 Pages Posted: 22 May 2000

See all articles by Rodrigo Valdés

Rodrigo Valdés

Central Bank of Chile; Ministry of Finance, Chile

Abstract

Using secondary market debt prices and country credit ratings, this paper provides evidence of contagion in emerging markets. It shows that fundamentals are unable to explain the cross-country comovement of creditworthiness in Latin American countries. It also shows that contagion cannot be explained by big news events, such as Brady announcements, and that it is asymmetric, being stronger for negative innovations in creditworthiness. In contrast, in a control group composed of US corporate bond prices and credit ratings of a group of medium size OECD countries, fundamentals explain all the observed correlation. The paper presents a simple model trying to explain this puzzle. It combines illiquid countries with investors who potentially need liquidity in order to change their portfolio. The basic intuition is that if investors require liquidity and they do not find it in one country, then they will seek funds in a second country. Under two alternative equilibrium definitions, the model shows that the probability of repayment of one country is negatively affected by the degree of illiquidity of other countries--an apparently country-specific characteristic.

JEL Classification: F33, F34

Suggested Citation

Valdés, Rodrigo O., Emerging Markets Contagion: Evidence and Theory. Available at SSRN: https://ssrn.com/abstract=69093 or http://dx.doi.org/10.2139/ssrn.69093

Rodrigo O. Valdés (Contact Author)

Central Bank of Chile ( email )

Agustinas 1180
Research Department
Santiago
Chile
+56 2 670 2000 (Phone)
+56 2 670 2231 (Fax)

Ministry of Finance, Chile

Teatinos 120
Santiago, 8340487
Chile

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