This paper summarizes “The Center and the Periphery: The Globalization of Financial Shocks," which presents a new approach to measure and understand systemic financial turbulences. We defined two measures of systemic disturbances: weak- and strong-form globalization and created the corresponding indices of “globalization.” These indices allowed us to capture the routes through which market jitters in one country reach other countries in the same region or even worldwide. They also allowed us to estimate the likelihood of low to high globalization following a variety of shocks in crisis-prone emerging markets and financial centers. One of the preliminary conclusions we draw from this exercise is that financial centers are at the core of “systemic” problems: The “worldwide globalization” of the turbulences in Asia in the Fall of 1997 only occurred after the stock market crash in the United States on October 27, while the Russian downfall spread around the globe only after it triggered fragilities in German banks and helped to provoke LTCM’s recapitalization.contagion, crisis, financial, global, regional

Kaminsky, Graciela

Reinhart, Carmen

English

Research Papers in Economics

Financial turmoil: systemic or regional? 
Risk Measurement and Systemic Risk, Proceedings of the Third Joint Central Bank 
Research Conference, (Basle: Bank of International Settlements, October 2002), 75-79. 
 
Graciela L Kaminsky, George Washington University and NBER 
Carmen M. Reinhart, University of Maryland, NBER and CEPR 
 
The crisis-prone 1990s and the crises of the new millennium have triggered an 
ever increasing interest in the globalisation of financial turbulence. Many argue that 
crises are of a regional nature and point to the debt crisis in 1982, which mostly engulfed 
Latin American countries, and to the so-called Asian flu, which spread from Thailand to 
Indonesia, Malaysia and the Philippines in a matter of days but left emerging markets in 
other regions mostly unscathed.4 Still, the Russian crisis in August 1998 and the 
debacle of financial markets around the world in autumn 1998 challenge this view and 
raise the question why some crises are only transmitted regionally while others affect 
countries around the globe. 
Kaminsky and Reinhart (2002) examine whether the degree of globalisation of 
financial turmoil depends on the origin of the shocks. In particular, they ask whether the 
extent of the spillover effects depends on whether the shock originates in the periphery or 
in the centre. For example, were the regional consequences of the Thai crisis so severe 
owing to Thailand’s direct links with other countries in the region or because that shock 
affected the region’s largest economy - Japan? Was the paralysis of the bond markets in 
many parts of the globe and the persistent equity market volatility due to the 
Russian default or to concerns that there might be more LTCMs in the making in the 
financial centres of the world? There may be various patterns in the propagation of shocks.  
First, there is the transmission of shocks from one periphery country to another 
periphery country, which can take place if the two countries are directly linked through 
bilateral trade or finance. Recent examples of this type of transmission mechanism 
include the adverse impact of the 1997-98 Asian crisis on Chilean exports and the 
contractionary consequences for Argentina of the Brazilian devaluation in early 1999.    
Second, the transmission of shocks from one periphery country to another 
periphery country may occur through a centre country. There are several prominent 
examples of this type of transmission mechanism. Corsetti et al (1998) model trade 
competition among the periphery countries in a common third “centre” market. For 
instance, Malaysia exports many of the same goods as does Thailand to Japan, Hong 
Kong and Singapore. Hence, when Thailand devalued in mid-1997, Malaysia lost its 
competitive edge in the common third markets. Another example of this channel of 
transmission is analysed in Kaminsky and Reinhart (2000), who focus on the role of 
commercial banks as lenders in the centrec ountry. For example, US banks had extensive 
exposure to Mexico in the early 1980s, much in the way that Japanese banks did to 
Thailand in 1997. The behaviour of the foreign banks can both exacerbate the original 
crisis, by calling loans and drying up credit lines, and propagate crises by calling loans 
elsewhere. The need to rebalance the overall risk of the bank’s asset portfolio and to 
recapitalise following the initial losses can lead to a marked reversal in commercial bank 
credit across markets where the bank has exposure.  
Third, shocks may be transmitted symmetrically from the centre country to the 
periphery. This is the type of shock stressed in Calvo, Leiderman, and Reinhart (1996), who analyse how changes in US interest rates influenced capital flows to Latin America 
in the early part of the 1990s. 
To examine the characteristics of international spillovers, we analysed the daily 
behaviour of stock markets for 35 emerging-to-mature market countries5 from January 
1997 to August 1999 and examined the degree of globalisation of extreme returns, which 
were defined as those returns in the 5th and 95th percentile of the distribution of returns. 
Since we were interested in the centre and the periphery, we examined what happens in 
stock markets around the world on days of turmoil in financial centres (Germany, Japan 
and the United States) and on days of turmoil in crisis-prone emerging economies (Brazil, 
Russia and Thailand). 
Our results indicate that turmoil in financial centres is an essential ingredient for 
systemic turbulence. For example, when there are market jitters in the United States, 
about 60% of emerging and mature markets worldwide also suffer market jitters. We also 
find that turmoil in crisis-prone emerging markets spills over into other countries when 
this turmoil affects financial centres (about 75% of mature and emerging markets 
worldwide are affected by market jitters in Brazil or Russia when either Germany or 
the United States are affected by those turbulences). But turbulences in crisis-prone 
emerging markets such as Brazil or Russia that do not affect financial centres do not have 
spillover effects worldwide (less than 15 of the countries are affected); they only spill 
over to other countries in the same region, with about 80% of the countries in Latin 
America being affected by financial turbulences in Brazil and about 40% of transition 
economies being affected by turmoil in Russia. That is, for worldwide globalisation of 
turmoil, financial centres have to be affected. Regional spillovers are different: trade links and wake-up calls may also have a contributing role. 
Finally, our research also examines what type of news triggers worldwide 
turbulences. We find that financial concerns from bankruptcies of large banks or adverse 
shocks in one particular financial  market seem to be at the core of high worldwide 
globalisation (76% of the episodes). Only 19% of the days of high spillovers seem to be 
driven by economic news. While financial worries are also at the core of high regional 
globalisation, their importance is moderate. Only 49% of the episodes of high regional 
globalisation are driven by financial concerns, with economic and monetary news 
explaining 37% of the episodes. 
While an analysis of more episodes is a clear necessity, one of the preliminary 
conclusions we draw from this exercise is that to understand “systemic” problems - be 
these defined at the global or regional level - we have to understand how a shock to the 
periphery spreads to the periphery (or to other financial centres), via its impact on a 
financial centre. If the shock never reaches the centre, it is doubtful it can become 
systemic, irrespective of the definition of systemic that is used. Because financial market 
participants at the centre countries were largely positioned for the collapse of Ecuador’s 
currency, banking system, economy and political system - not to mention its default on 
international obligations - these events were more of a ripple in global capital markets 
than a tidal wave. References 
Calvo, Guillermo A, Leonardo Leiderman and Carmen M Reinhart (1996): “Capital 
flows to developing countries in the 1990s: causes and effects”, Journal of Economic 
Perspectives, vol 10, spring, 123-39. 
 
Corsetti, Giancarlo, Paolo Pesenti, Nouriel Roubini and Cedric Tille (1998): Structural 
links and contagion effects in the Asian crisis: a welfare based approach, Yale University, 
mimeo. 
Glick, Reuven and Andrew Rose (1998): “Contagion and trade: why are currency crises 
regional?”,NBER Working Paper no 6806. 
 
Kaminsky, Graciela L and Carmen M Reinhart (2000): “On crises, contagion, and 
confusion”, Journal of International Economics. 
 
——— (2002): “The center and the periphery: the globalization of financial turmoil”, 
International Monetary Fund, Working Pape 
 Endnotes 
1 This chapter summarises some of the findings in Kaminsky and Reinhart (2002). 
2 See, for example, Glick and Rose (1998) and Kaminsky and Reinhart (2000). 
3 The 35 countries in our sample can be classified in five somewhat arbitrary groups: the 
G7 countries, namely Canada, France, Germany, Italy, Japan, United Kingdom and the 
United States; transition economies, comprising the Czech Republic, Estonia, Hungary, 
Poland, Russia, Slovakia and Ukraine; the Asian cluster, consisting of Hong Kong, 
Indonesia, Malaysia, the Philippines, Singapore, South Korea and Thailand; the “other 
European” group, which excludes those countries that are part of the G7 and comprises 
Finland, Greece, the Netherlands, Norway, Spain, Sweden and Turkey; and the Latin 
American group, which consists of the larger economies in the region: Argentina, Brazil, 
Chile, Colombia, Mexico, Peru and Venezuela. 
 
 

3 The 35 countries in our sample can be classified in five somewhat arbitrary groups: the G7 countries, namely Canada,

Capital flows to developing countries in the 1990s: causes and effects”,

Contagion and trade: why are currency crises regional?”,NBER Working Paper no 6806.

Nouriel Roubini and Cedric Tille

On crises, contagion, and confusion”,

Financial turmoil: Systemic or regional?

Financial turmoil: Systemic or regional?

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