Financial Contagion in Emerging Markets

Abstract: The fact that there were several similarities between the financial crises in Mexico 1995 and Asia 1997 makes it interesting to examine whether a model that explained the Mexican crisis also can be applied on the Asian crisis. Thus, this thesis aim is to do a quantitative study of nineteen emerging market economies with a model consisting of three explanatory variables: appreciated real exchange rate, weak banking system and scarce foreign exchange reserves. To the best of my knowledge, a follow-up study of this model has never been made before. Contribution: if the model does a good work explaining also the Asian crisis, it may be used by the market (e.g. international investors and currency traders) as an early warning indicator of future contagious crises in emerging markets. However, by running regressions I found that the R2 values are low (adjusted R2 are negative) and neither of the null hypotheses are significant at ten percents level. The conclusion is hence that the model does a poor job explaining what happened in Asia and that further research is needed in order to find a model which can explain patterns when financial crises in emerging markets becomes contagious due to creditors withdrawal of capital.