Open Economy, The Microscopic Mechanism Of Financial Contagion

Since the end of the 20th century, the international financial market has been increasingly unsettled, with the financial crises, turbulences and turmoil breaking out one after another, exerting great influence on the development of world economy. It is noticeable that all these economic crises or turmoil were clustered and became regional issues. This paper, with the approach of mathematical analysis, mainly discusses the microcosmic mechanism of financial contagion through the financial channel, by which the financial crisis is transferred from one country to another under the condition of open economy.The paper consists of 7 chapters. The first chapter is an introduction. The second chapter briefly reviews the course of the financial crisis development during the last decade and introduces the financial variables, the principal market participants and their behaviors which are related to the financial contagion. The third chapter discusses the mechanism inherent in the banking crisis contagion. The fourth chapter focuses on the relationship between portfolio diversification and financial contagion. In the fifth chapter examines the roles of information asymmetry and expectation in the financial contagion. Based on the theoretical analysis of the previous chapters, the sixth chapter probes into the key issues and the policy choices in tackling the financial contagion confronting China in the process of opening to the outside world The last chaper is a conclusion.The main findings of this paper are as follows:First, since 1990s, the financial crises have presented the charateristics of being clustered, contagious and concatenate. Such financial contagious effects do depend on the financial variables and economic fundmentals, but the real cause is the behaviors, attitudes, and mentalities of the microcosmic market participants.Secondly, as far as the banks are concerned, the contagion of banking panic and crisis happens via capital linkages between banks, through which the crisis spead from the debtor bank to the creditor bank.Thirdly, the institutional investors may diversify their portfolio in two or more countries, and due to the wealth effects, the returns of investments in the various countries have a positive correlative relationship among them, making the financial contagion possible.Fourthly, in the international financial market, apart from the liquidity shocks and the related information channels, the portfolio rebalance made by the market participants can easily transfer crisis from one country to another, even though there is no direct economic linkage between them. In such cases, the information asymmetry plays a key role.Finally, china's accession to the WTO will oblige Chinese financial market to undergo various imposed institutional changes. During the process of opening to the outside world, the Chinese economy is in face of an awkward predicament, caused by the potential problems of the ecomonic fundmentals, the external shocks and the expediting opening process.