On the epidemic of financial crises

Nikolaos Demiris, Theodore Kypraios, L. Vanessa Smith

Research output: Contribution to journalArticlepeer-review

Abstract

The paper proposes a framework for modelling financial contagion that is based on susceptible–infected–recovered transmission models from epidemic theory. This class of models addresses two important features of contagion modelling, which are a common shortcoming of most existing empirical approaches, namely the direct modelling of the inherent dependences that are involved in the transmission mechanism, and an associated canonical measure of crisis severity. The methodology proposed naturally implies a control mechanism, which is required when evaluating prospective immunization policies that intend to mitigate the effect of a crisis. It can be implemented not only as a way of learning from past experiences, but also at the on-set of a contagious financial crisis. The approach is illustrated on a number of currency crisis episodes, using both historical final outcome and temporal data. The latter require the introduction of a novel hierarchical model that we call the hidden epidemic model and which embeds the stochastic financial epidemic as a latent process. The empirical results suggest, among others, an increasing trend for global transmission of currency crises over time.
Original languageEnglish
Pages (from-to)697-723
JournalJournal of the Royal Statistical Society: Series A (Statistics in Society)
Volume177
Issue number3
Early online date17 Dec 2013
DOIs
Publication statusPublished - Jun 2014

Keywords

  • Contagion
  • Financial crisis
  • Markov chain Monte Carlo methods
  • Random graph
  • Stochastic epidemic model

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