Contagious currency crisis and spatial autocorrelation in the structure of foreign exchange

This thesis studies integration of the international financial system and the problem of so-called contagious currency crisis. This thesis follows two basic arguments. First is that integration of world capital markets takes place to a greater extent on a regional scale than it does on a global scale. Second is a restatement of the basic contagion hypothesis, which is the argument that a greater correlation of exchange rates occurs when higher volatility appears in the market. This study examines daily returns on rates of exchange for 81 currencies over the 1990 through 1998 period using spatial autocorrelation statistics Gi and Ii to measure integration among different currency portfolios, and tests the contagion hypothesis by using a logit model to define the extent of the relationship between market integration and volatility. Currency portfolios are based upon nearest neighbor sets and bloc groups representing countries of political, economic, and regional significance. This research contributes to knowledge about the global economy by quantifying integration and its relationship to volatility and provides an empirical basis for examining spatial patterns in the structure of foreign exchange. Results indicate that relatively few bloc groups display significant spatial autocorrelation, so from this perspective, world capital markets do not appear highly integrated. However, many of the nearest neighbor models of spatial autocorrelation are significant, providing evidence advancing the idea that regional organization exists within the structure of exchange. This result indicates that a more informal than formal process of integration takes place within the international financial system. The contagion models indicate that only a few countries, under limited conditions, demonstrate significant contagion effects in their exchange rate structure. The general conclusions of this study suggest little support for the contagion or globalization hypotheses exists. The finding of regional patterns in the structure of exchange is, however, significant because it is counterintuitive to the prevailing view of globalized foreign exchange markets and so contributes to the on-going debates about the organization of the international financial system and the world economy in general.