There is growing evidence that economic crises are transmitted across economies and equity markets. This motivates two questions. First, can the direction and magnitude of a country's stock market reaction during an extreme case ("contagion") be explained by economic fundamentals? Second, are there benefits of international diversification during times of widespread contagion among equity markets? We examine the reaction of major world equity markets to the 1997 Asian Crisis. In particular, we investigate the interrelationships among world equity markets, the factors explaining the different directions and magnitudes of countries' reactions to this crisis and the effectiveness of the global diversification of investment portfolios during financial crises. Our analyses provide evidence that is consistent with the correlations among world equity markets increasing dramatically during the period of the Asian Crisis. However, this effect is concentrated on a short period around the crisis. The benefits of international diversification may be obtainable, even when the period contains a worldwide financial crisis. We show that the productivity and interest rate macroeconomic variables, worldwide beta and the existence of derivatives trading are important in explaining the stock market returns during the Asian Crisis. The effect of the worldwide beta variable is particularly strong. Finally, the trade variables are insignificant, their influences being subsumed by interest rate and inflation macroeconomic variables. On balance, we interpret our results as supporting a rational view of the spread of an economic crisis to other markets.

This paper develops a model of private debt financing under inefficient financial intermediation. It suggests a mechanism that can generate the following sequence of events observed in the recent Asian crisis: A period of relatively low capital flow despite a steady improvement in economic fundamentals (capital inflow inertia), followed by a fast buildup of capital inflow, and ended with a large capital outflow and domestic credit crunch. Unlike other models requiring large movements in fundamentals or asset prices to explain a financial crisis, this model can exhibit large credit/capital flow swings with moderate changes in the economic and market environment.

Although the Asian Financial Crisis (AFC) has been over for many years, the influences of the AFC remain effect the world economy for quite severely. So it is worthy for both the governors and academic to study the lessons from the AFC and then find out some measures to avoid the happening of the crisis. This paper first analyze the causes of the financial crisis and the causes of the AFC, points out the impacts of China, which is the largest transition country in the world and has the situation similar with these Asian countries. This paper also point out some of the measures China can implement to accelerate the restructuring of the banking system.