Assignment 1: Read The Article "Open Your Market And Say Ahh
Assignment 1read The Article Open Your Market And Say Ahh Contag
Assignment 1Read the article "Open Your Market and Say "Ahh" , "Contagion Indicators" for an Ailing Global Economy. Write a critical review 2-3 page long addressing the following issues:. Identified the explanations for the financial crises affecting simultaneously few countries Identified and explain four models of financial contagion and their prospects for prediction and prevention Explain differences between financial crises in Argentina, South Africa and Southeast Asia All written assignments and responses should follow APA rules for attributing sources. Assignment 2 Discuss the advantages and disadvantages of futures contracts. Name two established exchanges where you would likely find future contracts traded. Post your work by Sunday, September 23, 2012 to the Discussion Area . Comment on two other postings by the end of the module. Your work should be 3-5 paragraphs long. All written assignments and responses should follow APA rules for attributing sources.
Paper For Above instruction
Introduction
The global financial system is intricately interconnected, and crises in one region can rapidly trigger contagion effects across multiple economies. The article "Open Your Market and Say 'Ahh': Contagion Indicators for an Ailing Global Economy" analyzes the underlying causes of such financial crises, explores various models to predict and prevent contagion, and compares specific case studies like Argentina, South Africa, and Southeast Asia. This review critically examines these perspectives, discusses foundational contagion models, and evaluates the distinctive features and impacts of the crises in these regions.
Explanations for Simultaneous Financial Crises
The article emphasizes several explanations for the simultaneous occurrence of financial crises across different countries. One primary cause is the highly interconnected nature of global financial markets, where shocks in one economy can swiftly propagate through capital flows, investor sentiment, and currency markets. For instance, during the late 1990s Asian financial crisis, a sudden withdrawal of foreign capital led to currency devaluations and banking collapses across Southeast Asian nations. The integration of financial markets means that vulnerability in a key economy can have ripple effects elsewhere, especially when contagion is facilitated through investor panic or herd behavior (Borio & Regeln, 2017).
Moreover, the phenomenon of 'common shocks', such as commodity price fluctuations or US Federal Reserve policy changes, can impact multiple economies simultaneously. As emerging markets often rely heavily on exports or foreign investment, sudden shifts in external conditions or investor sentiment can induce crises across countries experiencing similar vulnerabilities. Additionally, macroeconomic vulnerabilities, including high levels of debt, fiscal deficits, or weak financial regulation, exacerbate these risks, making countries more susceptible to contagion (Kaminsky & Reinhart, 2000).
The article also highlights the role of financial linkages through banks and corporate sectors. Cross-border banking has increased vulnerabilities because problems in the financial sector of one country can spill over into others via interconnected banking networks. The 2008 global financial crisis exemplifies how interconnected financial institutions multiply contagion effects, affecting even seemingly unrelated economies (Reinhart & Rogoff, 2009).
Models of Financial Contagion
Four prominent models of financial contagion are discussed in the article: the correlation-based model, the investor behavior model, the liquidity-based model, and the trust and sentiment model.
The correlation-based model suggests that contagion arises from increased correlations among financial assets across countries during crises. When correlations spike, diversification fails, and risk becomes more systemic. This model emphasizes statistical relationships but often struggles to distinguish between contagion and coincident movements driven by common shocks (Forbes & Rigobon, 2002).
The investor behavior model attributes contagion to herd mentality, where investors, reacting to negative news or market downturns, pull out investments simultaneously, amplifying shocks. This herding exacerbates declines and spreads panic quickly across markets (Bikhchandani et al., 1992).
The liquidity-based model focuses on how liquidity shortages can propagate contagion. As liquidity dries up in one country, investors withdraw their funds from other markets, leading to broader credit crunches. This model highlights how liquidity mismatches and funding freezes can escalate crises (Brunnermeier & Pedersen, 2009).
Lastly, the trust and sentiment model underscores the importance of confidence. A loss of trust in financial institutions or markets can trigger withdrawals and capital flight, which can rapidly spread across borders, especially in fragile economies (Kim & Westerhoff, 2010).
The prospects for prediction and prevention vary among these models. Correlation-based models can provide early warning signals of systemic risk but may produce false alarms during normal periods. Herd behavior models suggest the importance of market sentiment monitoring, though predicting investor panic remains difficult. Liquidity-focused models highlight the need for robust financial regulation, while trust-based models stress transparency and effective communication strategies.
Differences in Financial Crises: Argentina, South Africa, and Southeast Asia
The article delineates significant differences in the origins, progression, and impacts of financial crises in Argentina, South Africa, and Southeast Asia.
The Argentine crisis of 2001 was primarily rooted in macroeconomic mismanagement, including excessive reliance on short-term foreign debt, fixed exchange rate policies, and fiscal deficits. When investor confidence waned due to political instability and economic shocks, capital flight ensued, resulting in a sovereign debt default and economic collapse (Schlevogt, 2004).
In contrast, South Africa's 1998 crisis was largely driven by domestic macroeconomic vulnerabilities, including high inflation, currency overvaluation, and political uncertainty during the transition from apartheid to democracy. External shocks, such as the Russian financial crisis, compounded the problem, leading to currency depreciations and stock market declines (Gelbard, 2008).
The Southeast Asian financial crisis of 1997-1998 was characterized by a rapid withdrawal of foreign capital, predominantly driven by currency speculation and bank insolvencies. Structural weaknesses, such as inadequate financial regulation and high levels of short-term debt, exacerbated the contagion effect. Governments were forced to seek International Monetary Fund (IMF) assistance to stabilize their economies (Radelet & Sachs, 1998).
These crises differ in triggers—Argentina’s crisis was driven mainly by internal macroeconomic imbalances; South Africa’s involved a mixture of domestic vulnerabilities and external shocks; Southeast Asia’s was initiated by speculative attacks and structural weaknesses. The policy responses also varied: Argentina defaulted and implemented capital controls; South Africa adopted monetary tightening and reforms; Southeast Asian countries underwent IMF-led stabilization programs (Radelet & Sachs, 1998).
Conclusion
Understanding the causes and models of financial contagion is vital for developing effective policy responses to mitigate the impact of future crises. The differences among regional crises—Argentina, South Africa, and Southeast Asia—highlight the importance of tailored strategies that address specific vulnerabilities. Ultimately, strengthening financial regulations, improving transparency, and monitoring systemic risks are essential to prevent and manage contagion in an interconnected global economy.
References
Bikhchandani, S., Hirshleifer, D., & Welch, I. (1992). A theory of fashion adoption. Journal of Political Economy, 100(5), 992–1026.
Brunnermeier, M. K., & Pedersen, L. H. (2009). Market liquidity and funding liquidity. Review of Financial Studies, 22(6), 2201–2238.
Fores, R., & Rigobon, R. (2002). No contagion, only interdependence: Measuring stock market comovements. The Journal of Empirical Finance, 9(2), 182–223.
Gelbard, E. (2008). South Africa: Challenges in macroeconomic management. South African Journal of Economics, 76(4), 534–548.
Kaminsky, G. L., & Reinhart, C. M. (2000). On crises, contagion, and confusion. Journal of International Economics, 51(1), 145–168.
Kim, Y., & Westerhoff, F. (2010). Market sentiment and confidence levels in economic decision making. Applied Economics Letters, 17(14), 1371–1374.
Radelet, S., & Sachs, J. (1998). The East Asian financial crisis: Diagnosis, remedies, prospects. Brookings Papers on Economic Activity, 1998(1), 1–74.
Reinhart, C. M., & Rogoff, K. S. (2009). This time is different: Eight centuries of financial folly. Princeton University Press.
Schlevogt, K. (2004). The Argentine crisis: Causes and consequences. Economics & Politics, 16(3), 431–447.