Using Network-based Causal Inference to Detect the Sources of Contagion in the Currency Market

TL;DR

This paper introduces a network-based causal inference method to identify sources and pathways of contagion in the currency market, aiding risk assessment and diversification strategies.

Contribution

It presents a novel causal measure for contagion among currencies and applies it to the Forex market to trace contagion paths and systemic risk sources.

Findings

Identifies key currencies that propagate contagion.

Pinpoints currencies suitable for diversification.

Provides insights into systemic risk levels.

Abstract

Contagion is an extremely important topic in finance. Contagion is at the core of most major financial crises, in particular the 2008 financial crisis. Although various approaches to quantifying contagion have been proposed, many of them lack a causal interpretation. We will present a new measure for contagion among individual currencies within the Foreign exchange market and show how the paths of contagion work within the Forex using causal inference. This approach will allow us to pinpoint sources of contagion and to find which currencies offer good options for diversification and which are more susceptible to systemic risk, ultimately resulting in feedback on the level of global systemic risk.