The Channels for Financial Contagion
The seriousness of the recent Asian financial crises, and difficulties in finding macroeconomic explanations for its spread, have led to fears of irrational contagion, and to calls for additional regulation of financial markets. The message of this chapter is that it is premature to address contagion through new regulations until we have a better theoretical understanding of the mechanisms through which shocks are transmitted among markets, and knowledge of which theoretical channels are empirically relevant.1 To back up my claim that more and better theory is needed to understand contagion, it is useful to consider an example in which contagion is defined as a shock in one market or country that is transmitted to another market or country, but is not related to fundamentals. Similar definitions often appear in the literature on contagion.2.
KeywordsFinancial Market Financial Institution Mutual Fund Hedge Fund Financial Contagion
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