Financial contagion and contagion channels in the forex market: A new approach via the dynamic mixture copula-extreme value theory

Haiying Wang; Ying Yuan; Yiou Li; Xunhong Wang

doi:10.1016/j.econmod.2020.10.002

Financial contagion and contagion channels in the forex market: A new approach via the dynamic mixture copula-extreme value theory

Econ Model. 2021 Jan:94:401-414. doi: 10.1016/j.econmod.2020.10.002. Epub 2020 Oct 13.

Authors

Haiying Wang¹, Ying Yuan¹, Yiou Li², Xunhong Wang³

Affiliations

¹ School of Business Administration, Northeastern University, Shenyang 110169, China.
² Department of Mathematical Sciences, DePaul University, Chicago, IL 60605, USA.
³ School of Resources and Civil Engineering, Northeastern University, Shenyang 110819, China.

Abstract

We propose a new approach to the study of financial contagion and contagion channels in the forex market by using a dynamic mixture copula-extreme value theory (DMC-EVT) model. This method allows us to elucidate the complex and dynamic dependence between forex markets. By analyzing 39 currencies that are actively traded on the forex market during the period 2005-2009, our empirical study shows that the DMC-EVT model outperforms the alternative copula models. Furthermore, we confirm the existence of financial contagion in the forex market during the 2007-2009 global financial crisis, and find that wealth constraints are the contagion channel during the crisis. Our results provide important insights on portfolio and risk management.

Keywords: Contagion channels; Dynamic mixture copula; Extreme value theory; Financial contagion.