A new class of tests of contagion with applications

Abstract

A new class of tests of contagion is proposed identifying transmission channels of financial market crises through changes in higher order moments of the distribution of returns such as coskewness. Applying the framework to test for contagion in real estate and equity markets following the Hong Kong crisis in 1997–1998 and the U.S. subprime crisis in 2007 shows that the coskewness-based tests of contagion detect additional channels not identified by the correlation-based tests. Implications of contagion in pricing exchange options where there is a change in higher order comoments of returns on the underlying assets are also investigated.