Impact of Financial Crisis in SANE Economies: Test for Contagion

By

ACKNOWLEDGEMENT

I would first like to express my gratitude for my research supervisor, colleagues, and peers and family whose immense and constant support has been a source of continuous guidance and inspiration.

DECLARATION

I hereby certify that the work described in this thesis is my own work, except where otherwise acknowledged, and has not been submitted previously for a degree at this or any other university.

Signature:

Dated:

TABLE OF CONTENTS

ACKNOWLEDGEMENT2

DECLARATION3

ABSTRACT5

CHAPTER 1: INTRODUCTION6

CHAPTER 2: LITERATURE REVIEW11

Overview of Sane Economies14

Africa is the world's football largest and14

Relative Importance of the Sane Economies14

Key Economic Indicators15

Impact on SANE Economies17

Algeria17

Nigeria18

Egypt19

Sector of tourism20

Navigation in Suez Canal21

Oil sector21

Foreign direct investments22

Growth rate slowdown22

South Africa23

SANE Economies Reform Analysis24

The banking sector24

Stock Market25

CHAPTER 3: METHODOLOGY: TIME-VARYING CONDITIONAL COPULA AND AG-DCC-GARCH MODEL27

Conditional copula27

Regime Switches in Copula28

Estimation of parameters and models for marginal distributions29

The measurement of the dependence parameter30

AG-DCC-GARCH model31

Data32

CHAPTER 4: EMPIRICAL RESULTS34

Conditional Copula Estimates34

Estimates of the AG-DCC-GARCH model44

CHAPTER 5: CONCLUSION54

REFERENCES56

ABSTRACT

This paper investigates financial contagion in a multivariate time-varying asymmetric framework, focusing on four emerging equity markets, namely Egypt, Algeria, Nigeria, South Africa (SANE) and two developed markets (U.S. and U.K.), during five recent financial crises. Specifically, both a multivariate regime-switching Gaussian copula model and the asymmetric generalized dynamic conditional correlation (AG-DCC) approach are used to capture non-linear correlation dynamics during the period 1995-2006. The empirical evidence confirms a contagion effect from the crisis country to all others, for each of the examined financial crises. The results also suggest that emerging SANE markets are more prone to financial contagion, while the industry-specific turmoil has a larger impact than country-specific crises. Our findings imply that policy responses to a crisis are unlikely to prevent the spread among countries, making fewer domestic risks internationally diversifiable when it is most desirable.

CHAPTER 1: INTRODUCTION

The global extent of recent crises and the potential damaging consequences of being affected by contagion continuously attract attention among economists and policymakers. The transmission of shocks to other countries and the cross-countries correlations, beyond any fundamental link, has long been an issue of interest to academics, fund managers and traders, as it has important implications for portfolio allocation and asset pricing. Generally, contagion refers to the spread of financial disturbances from one country to others. The literature on financial contagion literally exploded since the thought-provoking paper by Forbes and Rigobon (2002) started circulating in the late 1990s. They define contagion as “a significant increase in cross-market linkages after a shock to one country (or group of countries)”, otherwise, a continued market correlation at high levels is considered to be “no contagion, only interdependence”. Since then, the existence of financial contagion has been studied by many researchers, mainly around the notion of “correlation breakdown” (a statistically significant increase in correlation during the crash period).1 For example, King and Wadhwani (1990) find evidence of an increase in stock returns' correlation in 1987 crash. Calvo and Reinhart (1996)report correlation shifts during the Mexican Crisis, while Baig and Goldfajn (1999) support the contagion phenomenon during the East Asian Crisis. Hon et al. (2007) find that technology bubble collapse in the ...