The Contagion Mechanism Of Financial Crisis And Policy Implications To China

In the 1990s Financial Crises were very frequent and usually spreaded worldwide. Many scholars focus on the characteristic that Financial Crises break out one by one in different countries Paul Masson defined this phenomena as Contagion, and gave us the reasons of Contagion.That were Monsoonal effects .Spillovers and Pure contagion. Afterwards further studies come forth and form a new branch of Crisis Theory.In this article, our study focuses on Spillovers and Pure contagion, because we define Contagion as the result that the probability of financial crisis rises due to crisis in another country.The mechanism of Contagion will tell us how Contagion comes ture .There are three kinds of the mechanism of Contagion, that is Trade Spillovers Mechanism, Financial Spillovers Mechanism, Pure Contagion Mechanism. Spillovers deteriorate the fundamentals of a country. When another currency depreciates, Loss of price competitiveness may cause trade deficit, unemployment, fall of price level and so on. Price is the main point in Trade Spillovers, so competitive depreciation may occur even though the fundamentals haven't really turned bad. Financial institutions such as bank and institutional investor change their asset in different markets, because lack of liquidity or in need of risk management. Through this way, Financial Spillovers engender in interrelated markets. There is another source of Contagion, even if there are no trade or financial market links between countries. That investors' anticipation changes because of another market 'crash may cause crisis. After a successful speculation, speculators are encouraged to attack another similar country. Investors panic emotion spreads and herd behavior appears, which make the economy jumps from a good equilibrium to a bad equilibrium.In the Asian Crisis, China successfully resisted crisis, mainly because at that time it's financial market hadn't opened completely. But there are still lots of risk factors in its financial system/The Asian Crisis teaches us a lesson that improper policies may cause disaster in financial system, such as indistinctive trade pattern, fully financial opening under immature domestic market.So in this article we explore how Contagion happens, then look for helpful countermeasures.