Working Paper: CEPR ID: DP13435
Authors: Tobias Adrian; Erik Vogt; Daniel Stackman
Abstract: We estimate a highly significant price of risk that forecasts global stock and bond returns as a nonlinear function of the VIX. We show that countries' exposure to the global price of risk is related to macroeconomic risks as measured by output, credit, and inflation volatility, the magnitude of financial crises, and stock and bond market downside risk. Higher exposure to the global price of risk corresponds to both higher output volatility and higher output growth. We document that the transmission of the global price of risk to macroeconomic outcomes is mitigated by the magnitude of stabilization in the Taylor rule, the degree of countercyclicality of fiscal policy, and countries' tendencies to employ prudential regulations. The estimated magnitudes are quantitatively important and significant, with large cross sectional explanatory power. Our findings suggest that macroeconomic and financial stability policies should be considered jointly.
Keywords: financial stability; monetary policy; fiscal policy; regulatory policy
JEL Codes: G12; G17; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| global price of risk (G19) | output volatility (E23) |
| global price of risk (G19) | output growth (O40) |
| global price of risk (G19) | output (C67) |
| global price of risk (G19) | short rates (E43) |
| global price of risk (G19) | stock markets (G10) |
| magnitude of stabilization in the Taylor rule (E63) | transmission of global price of risk to macroeconomic outcomes (E44) |
| countercyclical fiscal policy (E62) | transmission of global price of risk to macroeconomic outcomes (E44) |
| prudential regulations (G28) | transmission of global price of risk to macroeconomic outcomes (E44) |
| macroeconomic stability policies + financial stability policies (E63) | risk-return tradeoff across countries (G15) |