Financial contagion and contagion channels in the forex market: A new approach via the dynamic mixture copula-extreme value theory

We propose a new approach to the study of financial contagion and contagion channels in the forex market by using a dynamic mixture copula-extreme value theory (DMC-EVT) model. This method allows us to elucidate the complex and dynamic dependence between forex markets. By analyzing 39 currencies that are actively traded on the forex market during the period 2005–2009, our empirical study shows that the DMC-EVT model outperforms the alternative copula models. Furthermore, we confirm the existence of financial contagion in the forex market during the 2007–2009 global financial crisis, and find that wealth constraints are the contagion channel during the crisis. Our results provide important insights on portfolio and risk management.