Financial linkages among the Asian crisis economies

In the literature, there are two explanations for the contagion effects of currency crisis. The first one is through the trade links, while the second one is through the transmission of information via the similarity of macroeconomic variables among the crisis countries. In this paper, we suggest that there may be a third explanation complementary to the two above: Contagion of currency crisis could occur through the financial linkages among the crisis countries. This explanation fits well with the anecdotes of the 1997-98 East Asian currency turmoil. This paper is organised as follows. Section 2 provides a simple framework on regional financial linkages. Section 3 proceeds with an empirical verification of the financial linkage hypothesis, using data prior to the currency crisis of 1997-98. Because of the structural break from the crisis, data after 1997 is excluded from the estimation. If the contagion indeed spreads through the financial linkages of the region, it is necessary that the connections among financial variables within the Asian crisis economies be of significant magnitude. Section 4 concludes.