Effects of current turmoil in emerging markets may be less widespread than in previous crises

AuthorSubir Lall
PositionIMF International Capital Markets Department
Pages270-271

Page 270

Asalient feature of emerging markets has been their susceptibility to sharp spikes in volatility and "contagion" across countries as well as markets during periods of crisis. By the broadest measure, contagion would imply a co-movement in asset prices in excess of what may be explained by macroeconomic fundamentals. Recent credit concerns relating to Argentina and Turkey and the associated rise in market volatility have prompted comparisons of the extent of contagion compared with previous crisis episodes.While there clearly were specific instances of spillover of market volatility arising from particular country credit concerns to other countries, an assessment of how widespread it was needs a more precise measure. One such measure of contagion-the average cross-country correlation of returns-provides an indication of the extent of co-movement of individual country returns and indicates periods of broadbased selling or buying of emerging markets.

Contagion can, and indeed does, occur at high frequencies- for example, daily. It is not generally possible to get high-frequency observations on macroeconomic fundamentals on similar high frequencies.

High values for the average cross-correlation are consistent with a number of factors: common country fundamentals; real and financial linkages across countries; common external shocks; and lack of investor discrimination. In the present situation, common external factors and lack of investor discrimination are the more likely key factors explaining spikes in observed correlations.

Emerging debt markets

It is evident that there were large spikes in the average cross-correlation associated with the major emerging market crises: the Tequila crisis in early 1995; the attacks on the Thai baht in early May 1997; the October 1997 Asian crisis; and the Russian default in August 1998 (see chart, page 270). The Turkish devaluation in February 2001 led to a modest rise in the average cross-correlation to 0.43. During the April Argentina sell-off, which saw sovereign spreads reach nearly 1,300 basis points, the average correlation was 0.45. Similarly, the most recent sell-off in Argentina during July, which saw sovereign spreads peak at over 1,600 basis points, resulted in an increase in average correlations, but to a relatively modest 0.47. In all three of the recent episodes of heightened credit concerns, therefore, the...

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