New Zealand's most admired writer, Janet Frame, has died of leukaemia in the South Island town of Dunedin, aged 79.

Alongside the modernist short-story writer Katherine Mansfield who died in 1923, Frame was reckoned to be New Zealand's greatest author.

"It's like the lights have gone out," said the Auckland-based novelist Witi Ihimaera. "The sun has gone out in New Zealand literature today."

Frame was twice mentioned as a frontrunner for the Nobel prize for literature - most recently last October when she was singled out as a committee favourite before the award was taken by South African writer JM Coetzee.

At the time she had already been diagnosed with the cancer that would kill her.

She will be remembered for her depictions of mental illness and the damaging impact of life in mental institutions, drawing insight from the 10 years she spent in psychiatric hospitals after being misdiagnosed with schizophrenia after a breakdown in 1945.

She described her time in hospital as a "concentrated course in the horrors of insanity".

"As the years passed and the diagnosis remained, with no one apparently questioning it ... I felt hopelessness at my plight," she wrote.

In her three-volume autobiography she describes how she was subjected to electro-shock treatment and would have been lobotomised in 1952 had her first collection of short stories, The Lagoon, not won New Zealand's only book prize.

In later life she resented the belief that she was insane, her writing the outpourings of a mad genius. Most of her later work had little to do with mental illness and she wrote until the end of her life, although her last published work, The Carpathians, came out in 1988.

During her career she lived in Britain, the US, Spain and Andorra, but after her return to New Zealand in the 1980s she became increasingly reclusive. She once walked out of a New Zealand literary conference at which she was guest of honour because a speaker offered her an ovation.

Her autobiography, which introduced her work to a wider audience when it was filmed as An Angel at my Table by the director Jane Campion in 1990, was partly written as an attempt to quell the appetite for information about her life.