A multifactor model of exchange rates is proposed which allows for both time-dependent common and idiosyncratic factors, as well as unanticipated shocks across currency markets. This latter feature of the model is exploited in the empirical application to measure the contribution of contagion to the volatilities of exchange rates during the East Asian currency crisis. The empirical results show evidence of significant contagion. The contribution of contagion is estimated at 9 per cent of total volatility for the Thai baht and 46 per cent for the South Korean won. Indonesia is found to be the most affected in terms of basis points.
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