ABSTRACT
To be sure, a serious downside of financial globalization is the so-called “contagion effect.” The communicable nature of recent financial and currency crises has been the center of economic discussions among academics as well as in policy circles. The contagion effect implies that a crisis generated in one emerging market economy is transmitted to another seemingly unrelated emerging market, if the economy is open and integrated with the global economy. In fact, the crisis may be transmitted to the whole region, even spread globally. For instance, the crisis and sovereign default in the Russian Federation in August 1998 triggered a pervasive widening of credit spreads and generalized risk aversion in the financial markets.1 It also triggered fragilities in German banks and helped to provoke LongTerm Capital Market’s (LTCM’s) near-bankruptcy in September 1998, before spreading its impact around the globe.2 By the end of 1998, as noted above, the impact of the Russian and LTCM crises combined to increase substantially the volatility in the global securities markets. A reassessment of credit and sovereign risks during this period led to large jumps in credit and liquidity spreads as well as in risk premia in both emerging market and industrial economies. This episode of financial distress has special significance because of its global ramifications (BIS, 1999).3 Following the Russian crisis and default, many currency markets became inordinately volatile and global security markets seized-up (Loisel and Martin, 2001).
