Financial contagion among members of the EU‐8: A cointegration and Granger causality approach

Abstract

Purpose

The purpose of this paper is to examine whether the banking crisis in the USA and Western Europe that began in August 2007 spilled over to the currencies of the EU‐8 such that it could be viewed as financial contagion. The currencies of the EU‐8 which the paper aims to study are of the Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland and Slovakia, daily, from 2005 to 2008.

Design/methodology/approach

Contagion is said to be revealed if there are greater links after August 2007 compared with before. The links or bonds are revealed by the number of cointegrating vectors and the extent of Granger causality that exists among the currencies. The role of the euro is also identified using the same techniques.

Findings

The bonds between these seven countries strengthen after the beginning of the banking crisis compared with before, whilst the ties with the euro remains stable.

Research limitations/implications

A banking crisis not directly related to the EU‐8 spilled over to a change in the correlations among their currencies. If the EU requires convergence of emerging with developed markets before currency assimilation, research is needed to explore how a record of financial rectitude can be demonstrated whilst recognising that contagion is more likely to affect those emerging markets and information deficiencies.

Practical implications

First, the EU should reconsider the entry requirements for the EU‐8 still disqualified from joining the euro. The protected two‐year period of displaying financial rectitude via targeting the euro before accession is considered may now appear a burden that to great for small economies to bear. Second, it is not necessarily a crisis that changes the rewards from diversification, contagion may also do this.

Originality/value

The finding of increased bonding among emerging market currencies precipitated by a banking crisis in related geographical and financial markets, before a local crisis became evident is novel.

Citation

Gray, D. (2009), "Financial contagion among members of the EU‐8: A cointegration and Granger causality approach", International Journal of Emerging Markets, Vol. 4 No. 4, pp. 299-314. https://doi.org/10.1108/17468800910991214