Modeling financial contagion using mutually exciting jump processes

Yacine Aït-Sahalia, Julio Cacho-Diaz, Roger J.A. Laeven

Research output: Contribution to journalArticle

155 Scopus citations

Abstract

We propose a model to capture the dynamics of asset returns, with periods of crises that are characterized by contagion. In the model, a jump in one region of the world increases the intensity of jumps both in the same region (self-excitation) as well as in other regions (cross-excitation), generating episodes of highly clustered jumps across world markets that mimic the observed features of the data. We develop and implement moment-based estimation and testing procedures for this model. The estimates provide evidence of self-excitation both in the US and the other world markets, and of asymmetric cross-excitation, with the US market typically having more influence on the jump intensity of other markets than the reverse. We propose filtered values of the jump intensities as a measure of market stress and examine their out-of-sample forecasting abilities.

Original languageEnglish (US)
Pages (from-to)585-606
Number of pages22
JournalJournal of Financial Economics
Volume117
Issue number3
DOIs
StatePublished - Sep 1 2015

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Keywords

  • Contagion
  • Crisis
  • Hawkes process
  • Jumps
  • Self- and mutually exciting processes

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