Testing contagion of the 1997-98 crisis in Asian stock markets with structural breaks and incubation periods

This study tests for the existence of financial contagion, using a method that allows an incubation period before contagion takes effect. We define contagion as an increase in cross-market linkages following shocks. With daily data on Asian stock markets during the 1997-98 crisis, we find significant upward shifts in the linkages between the Asian markets of both crisis and non-crisis countries. The upward shifts are maintained even after controlling for heteroskedasticity and common world and regional factors, providing strong evidence for financial contagion.

► The study provides strong evidence for the existence of financial contagion during the Asian crisis. ► The evidence remains robust even when global and regional factors, as well as heteroskedasticity and serial correlation, are controlled for. ► The stock markets in the so-called the non-crisis countries, such as China and Taiwan, were also affected by the financial crisis in other Asian markets. ► The contagion to China was mostly to the small portion of the Chinese market that was open to foreign investors.