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SUMMARYAn empirical model of multiple asset classes across countries is formulated in a latent factor framework. A special feature of the model is that financial market linkages during periods of financial crises, including spillover and contagion effects, are formally specified. The model also captures a range of common factors including global shocks, country and market shocks, and idiosyncratic shocks. The framework is applied to modelling linkages between currency and equity markets during the East Asian financial crisis of 1997-98. The results provide strong evidence that cross-market links are important. Spillovers have a relatively larger effect on volatility than contagion, but both are statistically significant.

SUMMARYA factor analysis of long-term bond spreads is performed by decomposing international interest rate spreads into national and global factors. The factors are latent, and are assumed to have GARCH-type speci®cations as well as exhibiting serial dependence. An indirect estimator is used to compute estimates of the unknown parameters. The sampling performance of this estimator is investigated and compared with an alternative direct estimator based on the Kalman predictor. The factor model is applied to weekly data on long-bond spreads between ®ve countries Ð Australia, Japan, Germany, Canada and the UK Ð and the USA over the period 1991 to 1999. The resulting factor decomposition is used to examine the international investor's optimal portfolio decision in a mean-variance framework.

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. The existing literature suggests a number of alternative methods to test for the presence of contagion during financial market crises. This paper reviews those methods and shows how they are related in a unified framework. A number of extensions are also suggested that allow for multivariate testing, endogeneity issues, and structural breaks.

The Russian and LTCM crises of August-September 1998 represent an unusual period of volatility in international bond markets with bond spreads increasing dramatically across the globe. Using a latent factor model and a new data set spanning markets across Asia, Europe and the Americas, we quantify the contribution of contagion to the spread of these crises. Contagion accounts for less than 17 percent of total volatility, with the main effects due to the Russian crisis. Both developing and developed markets experienced contagion from both crises. The relatively larger contagion experienced in developing markets is a reflection of their higher volatility. JEL Classification Numbers: C33, E44, F34

On April 18, 2001 US Federal Reserve Open Market Committee (FOMC) surprised …nancial markets by lowering the Federal Funds Target rate 1 2 % between regularly scheduled FOMC meeting dates. Securities markets in the US and Australia responded. The US 30-Euro$ rate fell by 1 2 %.and US and Australian …ve year bond yields fell by about 13 basis points. Equity returns increased by 3% in the US and 1 1 2 % in Australia. This paper is the …rst to examine international monetary policy surprise spillovers and to estimate the response of security prices to unobservable monetary and nonmonetary surprises.Our estimates of the impact of domestic monetary policy surprises on domestic yields and returns are similar to other studies. The following results are new. US monetary policy surprises spill over and a¤ect Australian yields and equity returns. Australian monetary surprises do not spill over to the US. Nonmonetary surprises are more important in explaining the movements in longer maturity yields and returns than monetary policy surprises.

A structural vector autoregression model is used to identify overvaluation in house prices in Australia from 2002 to 2008. An important feature is the development of a housing sector where long-run restrictions are derived from theory to identify housing demand and supply shocks. The results show strong evidence of overvaluation in real house prices, reaching a peak of just over 15 per cent by the end of 2003. Factors driving overvaluation are housing demand shocks before 2006 and post-2006 macroeconomic shocks. Wealth effects from equity markets are also important. The results suggest that monetary policy is not an important contributor to overvaluation of house prices.* We thank the comments and suggestions of two referees who significantly helped to improve the paper.