The Dynamics of Global Financial Crises

This paper presents a Markov chain model of the transmission of financial crises. Using bilateral trade data and a measure of exchange market pressure, a method to determine a set of transition probabilities that describes the crisis transmission dynamics is developed. The dynamics are characterized by one-month conditional crisis probabilities and the probability of a crisis occurring within one year. The framework allows for modeling and comparing various channels of contagion, such as investments and bilateral trade. Using macroeconomic data on 45 countries, the model predicts and gives insights into the following crises: Mexico (1994), Asia (1997), Russia (1998), Brazil (1999), Turkey (2001), and Argentina (2002).