Tranquil and crisis windows, heteroscedasticity, and contagion measurement: MS-VAR application of the DCC procedure

Abstract

The key objective of this study is to show that two potential shortcomings of the Determinant of Change in Covariance (DCC) matrix procedure of Rigobon (2003), namely with the arbitrary determination of the windows, i.e. tranquil and crisis periods and the violation of its heteroscedasticity assumption under the null, can be simultaneously addressed via a simple incorporation of a Markov-switching vector autoregressive approach into the overall DCC procedure. To demonstrate this, we revisit the period around the time of the East Asian crises using daily stock exchange of Indonesia, Malaysia, Philippines, Thailand, Singapore, Korea, Hong Kong and Taiwan, and test whether there is a significant break or discontinuity in the stock exchange returns of the eight East Asian markets during crisis periods, especially around the time of the 1997 financial crises. In contrast to that of Rigobon (2003), our results show that the propagation of shocks shifted significantly starting with the onset of the sharp decline in the Hong Kong stock market.