The role of U.S. subprime mortgage-backed assets in propagating the crisis: Contagion or interdependence?

Lisa Sheenan, Thomas Flavin

Research output: Contribution to journalArticlepeer-review

19 Citations (Scopus)

Abstract

Though relatively small, the subprime mortgage-backed securities market is often identified as the source of the crisis that swept through the U.S. financial system from 2007 onwards. We investigate if its role in the propagation of the crisis was due to contagion or interdependence. Using a Markov-switching VAR with time-varying transition probabilities, we analyse the transmission of shocks across the financial system. We find little evidence of asset correlation changes between normal and crisis regimes and those that do occur are predominantly associated with liquidity variables. Otherwise, relationships are stable across market conditions, implying that the U.S. financial crisis was due to cross-market interdependencies rather than contagion. There is limited evidence that the deteriorating quality of the underlying assets can explain the transition from ‘normal’ market conditions to a high-volatility regime, although this is not consistent across model specifications.
Original languageEnglish
Article number34
Pages (from-to)167-186
Number of pages20
JournalThe North American Journal of Economics and Finance
Volume34
Publication statusPublished - 01 Nov 2015

Keywords

  • financial crisis
  • Contagion
  • Subprime mortgage backed securities
  • Markov switching VAR

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