Contagion

What is 'Contagion'

Contagion is the spread of market changes or disturbances from one regional market to others. Contagion can refer to the diffusion of either economic booms or economic crises throughout a geographic region.

BREAKING DOWN 'Contagion'

Contagions occur both globally and domestically, but they have become more prominent phenomena as the global economy has grown and economies within certain geographic regions have become more correlated with one another. Contagion is seen by many scholars as being primarily symptomatic of global market interdependence.

Usually associated with a financial crisis, contagions can be manifested as negative externalities diffused from one crashing market to another. In a domestic market, it can occur if one large bank sells most of assets quickly and confidence in other large banks drops accordingly. In principle, the same process occurs when international markets crash, but  Globally, cross-border investment and trade can resultant in quick crashes of closely correlated regional currencies, as in the 1997 crisis when the Thai baht collapsed and market shocks quickly spread to nearby East Asian countries, resulting in widespread currency and market crises in the region. Fallout from the crisis also struck emerging markets in Latin America and Eastern Europe, indicative of the capacity of contagions to spread quickly beyond regional markets.

Contagions are named as such for their potential to spread quickly and (seemingly) unexpectedly.  Global investment and cross-border trade makes financial contagions more likely, especially among developing countries or emerging markets.  In these markets, contagions are often exacerbated by asymmetric information, which results in both unsustainable investments and reactionary market downturns in response to the weakening of nearby or closely correlated markets.  Larger and more established markets are better able to weather financial contagions than developing economies; despite neighboring most of the Asian countries afflicted by the crisis, China's markets emerged largely unscathed.

A Brief History of Financial Contagion

The term was first coined during the 1997 Asian financial markets crisis, but the phenomenon had been functionally evident much earlier.

After the Asian financial crisis, scholars started to investigate how previous financial crises spread across national borders, and they concluded that the "nineteenth century had periodic international financial crises in virtually every decade since 1825." In that year, a banking crisis that originated in London spread to the rest of Europe and eventually Latin America. In a pattern that has been repeated ever since, the roots of the crisis were in revolution and growth at the periphery of the global financial system. After much of Latin America had been liberated from Spain in the early part of the 19th century, speculators in Europe poured cash into the continent. Investment in Latin America became a speculative bubble, and in 1825, the Bank of England, fearing massive gold outflows, raised its discount rate, which in turn sparked a stock market crash. The ensuing panic spread to continental Europe. 

The global Great Depression, caused by the 1929 U.S. stock market crash, remains an especially recent and striking example of the effects of contagion on an integrated global economy.

 

RELATED TERMS
  1. The Great Recession

    The steep decline in economic activity during the late 2000s, ...
  2. European Sovereign Debt Crisis

    A period of time in which several European countries faced the ...
  3. Spread

    1. The difference between the bid and the ask price of a security ...
  4. Geographical Diversification

    The practice of diversifying an investment portfolio across different ...
  5. Regional Fund

    A mutual fund that confines itself to investments in securities ...
  6. Reverse Calendar Spread

    An options or futures spread established by purchasing a position ...
Related Articles
  1. Investing Basics

    Logic: The Antidote To Emotional Investing

    Playing follow-the-leader in investing can quickly become a dangerous game. Learn how to invest independently and still come out on top.
  2. Economics

    What is a Financial Crisis?

    A financial crisis is a situation in which the values of assets drop rapidly.
  3. Insurance

    Riding The Market Bubble: Don't Try This At Home

    Riding the bubble takes timing, a clear understanding of the market and, most of all, a lot of luck.
  4. Investing

    Latin America’s Economic Forecast

    After a ten-year run, the economies of Latin America are in a decline. For sustainable, long-term growth, the region needs structural reforms.
  5. Personal Finance

    Examining Credit Crunches Around The World

    Market tops and bottoms have proliferated the financial markets throughout history. Learn how countries dealt with these tough economic periods.
  6. Forex Fundamentals

    What Causes A Currency Crisis?

    Find out what can cause a currency to collapse, and what central banks can do to help.
  7. Mutual Funds & ETFs

    The 3 Best Mutual Funds to Short Global Equities (GRZZX, UXPIX)

    Discover the three best mutual funds that bearish investors can use to short global markets, and learn which fund is best suited for your portfolio.
  8. Economics

    5 Other Countries Affected By A Troubled Europe

    These countries have significant trading relationships with European countries, and could feel the brunt of a euro collapse.
  9. Personal Finance

    The Banking System: Commercial Banking - Bank Crises And Panics

    ByStephen D. Simpson, CFA It is not altogether unreasonable to say that the history of banking in the United States is a history of panics and crises. Most history books cite at least ten distinct ...
  10. Personal Finance

    Investing In Emerging Market Debt

    This asset class has left much of its unstable past behind. Find out how to invest in it.
RELATED FAQS
  1. What are the typical day-to-day responsibilities of a Chief Operating Officer (COO)?

    Learn how a country's debt crisis affects the world, including how currency values, inflation and output are affected on ... Read Answer >>
  2. What are some examples of financial spread betting?

    Learn how financial spread betting is done, and see examples of some of the ways that investors can use spread betting as ... Read Answer >>
  3. What are the biggest risks involved with financial spread betting?

    Learn about financial spread betting, the risks involved with spread betting and the dangers of placing financial spread ... Read Answer >>
  4. What types of stocks have a large difference between bid and ask prices?

    Find out which factors influence bid-ask spread width. Learn why some stocks have large spreads between bid and ask prices, ... Read Answer >>
  5. How do I set a strike price in an options spread?

    Find out more about option spread strategies, and how to set the strike prices for bull call spreads and bull put spreads ... Read Answer >>
  6. How did the financial crisis affect the oil and gas sector?

    Learn how the financial crisis affected the oil and gas sector. The financial crisis led to a contraction in economic activity ... Read Answer >>
Hot Definitions
  1. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  2. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  3. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  4. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  5. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  6. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
Trading Center