NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

NBER Working Papers by Roger J.A.. Laeven

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Working Papers

March 2010Modeling Financial Contagion Using Mutually Exciting Jump Processes
with Yacine Aït-Sahalia, Julio Cacho-Diaz: w15850
Adverse shocks to stock markets propagate across the world, with a jump in one region of the world seemingly causing an increase in the likelihood of a different jump in another region of the world. To capture this effect mathematically, we introduce a model for asset return dynamics with a drift component, a volatility component and mutually exciting jumps known as Hawkes processes. In the model, a jump in one region of the world or one segment of the market increases the intensity of jumps occurring both in the same region (self-excitation) as well as in other regions (cross-excitation). The model generates the type of jump clustering that is observed empirically. Jump intensities then mean-revert until the next jump. We develop and implement an estimation procedure for this model. Our e...

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