Politická ekonomie
Politická ekonomie
Prague Economic Papers
University of Economics, Prague

Prague Economic Papers Vol. 26 No. 6

Foreign Exchange Market Contagion in Central Europe from the Viewpoint of Extreme Value Theory

DOI: https://doi.org/10.18267/j.pep.634

[full text (PDF)]

Narcisa Kadlčáková, Luboš Komárek

This paper examines contagion in the foreign exchange markets of three Central European countries and the euro area. Contagion is viewed as the occurrence of extreme events taking place in different countries simultaneously and is assessed with a measure of asymptotic tail dependence among the studied distributions. Currency crisis contagion is one strand of this research. However, the main aim of the paper is to examine the potential of bubble contagion. To this end the representative exchange rates are linked to their fundamentals using a cointegration approach. Given the long-time range required by cointegration testing, the variables are first tested for unit roots with structural breaks, whose existence is supported by these tests. In the sequel, the extreme values of the differences between actual daily exchange rates and their monthly equilibrium values determine the episodes associated with large departures from equilibrium. Using tools from Extreme Value Theory, we analyse the transmission of both standard crisis and bubble formation events in the examined currency markets. The results reveal a significant potential for contagion in the currency markets of Central Europe.

Keywords: contagion, exchange rate, extreme value theory

JEL Classification: C58, E44, G12


Andrews, D. W. K., Ploberger, W. (1994). Optimal Tests When a Nuisance Parameter is

Present Only under the Alternative. Econometrica, 62(6), 1383–1414, https://doi.


Bubák, V., Kočenda E., Žikeš, F. (2011). Volatility Transmission in Emerging European Foreign Exchange Markets. Journal of Banking and Finance, 35(11), 2829–2841, https://doi.


Cumperayot, P., Kouwenberg, R. (2013). Early Warning Systems for Currency Crises:

A Multivariate Extreme Value Approach. Journal of International Money and Finance, 36,

151–171, https://doi.org/10.1016/j.jimonfin.2013.03.008

Eichengreen, B., Rose, A. K., Wyplosz, C. (1996). Contagious Currency Crises. National Bureau of Economic Research. Cambridge Working Paper No. 5681, https://doi.org/10.3386/


Embrechts, P., McNeill, A., Straumann, D. (2002). Correlation and Dependence Properties

in Risk Management: Properties and Pitfalls. Risk Management: Value at Risk and Beyond,

Cambridge: Cambridge University Press, https://doi.org/10.1017/cbo9780511615337.008

Engel, C., West, K. D. (2004). Exchange Rates and Fundamentals. National Bureau of Economic Research. Cambridge Working Paper No. 10723, https://doi.org/10.3386/w10723

Hartmann, P., Straetmans, S., de Vries, C. G. (2004). Asset Market Linkages in Crisis

Periods. The Review of Economics and Statistics, 86(1), 313–326, https://doi.


Hartmann, P., Straetmans, S., de Vries, C. G. (2010). Heavy Tails and Currency Crises. Journal of Empirical Finance, 17, (2), 241–254, https://doi.org/10.1016/j.jempfin.2009.09.004

Kaminsky, G. L., Lizondo, S., Reinhart, C. M. (1998). Leading Indicators of Currency Crises. Staff Papers, 45(1).

Kaminsky, G. L., Reinhart, C. M. (2000). On Crises, Contagion and Confusion.

Journal of International Economics, 15(1), 145–168, https://doi.org/10.1016/


Kaminsky, G. L. (2003). Varieties of Currency Crises. National Bureau of Economic Research. Cambridge Working Paper No. 10193, https://doi.org/10.3386/w10193

Kaminsky, G. L. (2006). Currency Crises: Are They All the Same? Journal of International Money and Finance, 25(3), 503–527, https://doi.org/10.1016/j.jimonfin.2006.01.002

Kim, D., Perron, P. (2009). Unit Root Tests Allowing for a Break in the Trend Function at an Unknown Time under Both the Null and Alternative Hypotheses. Journal of Econometrics,

148(1), 1–13, https://doi.org/10.1016/j.jeconom.2008.08.019

Komárek, L. Kubicová, I. (2011). The Classification and Identification of Asset Price Bubbles. Czech Journal of Economics and Finance 61(1), 34–48.

Ledford, A. W., Tawn, J. A. (1996). Statistics for Near Independence in Multivariate Extreme Values. Biometrika, 83(1), 169–187, https://doi.org/10.1093/biomet/83.1.169

Loaiza-Maya, R.A., J. E. Gomez-Gonzales, Melo-Velandia, L. F. (2015). Exchange Rate

Contagion in Latin America. Research in International Business and Finance, 34, 355–367,


Perron, P. (1989). The Great Crash, the Oil Price Shock, and the Unit Root Hypothesis.

Econometrica, 57(6), 1361–1401, https://doi.org/10.2307/1913712

Perron, P., Yabu, T. (2007). Testing for Shifts in Trend with an Integrated or Stationary Noise Component. Journal of Business and Economic Statistics, American Statistical Association, 27(3), 369-396, https://doi.org/10.1198/jbes.2009.07268

Poon, S., Rockinger, M., Tawn, J. (2003). Extreme-Value Dependence in Financial Markets:

Diagnostics, Models and Financial Implications. Review of Financial Studies, 17(2), 581–610, https://doi.org/10.1093/rfs/hhg058

Schmuki, S. N. (2008). Tail Dependence: Implementation, Analysis, and Study of the Most Recent Concepts. Master Thesis, Swiss Federal Institute of Technology Zurich.

Vries, de, C. G. (2005). The Simple Economics of Bank Fragility. Journal of Banking and Finance, 29(4), 803–825, https://doi.org/10.1016/j.jbankfin.2004.08.003