A Markov regime switching model of crises and contagion: The case of the Iberian countries in the EMS

► We develop a general econometric model of currency crises and contagion. ► The model has time-varying transition probabilities and shifting correlations. ► We analyze the Portuguese escudo and Spanish peseta during the EMS crisis. ► Interest rate differential has perverse effects in Portugal but positive in Spain. ► There is strong evidence of contagion mostly from the peseta to the escudo.