Working Paper: CEPR ID: DP8787
Authors: Alexander Chudik; Marcel Fratzscher
Abstract: The paper analyses the transmission of liquidity shocks and risk shocks to global financial markets. Using a Global VAR methodology, the findings reveal fundamental differences in the transmission strength and pattern between the 2007-08 financial crisis and the 2010-11 sovereign debt crisis. Unlike in the former crisis, emerging market economies have become much more resilient to adverse shocks in 2010-11. Moreover, a flight-to-safety phenomenon across asset classes has become particularly strong during the 2010-11 sovereign debt crisis, with risk shocks driving down bond yields in key advanced economies. The paper relates this evolving transmission pattern to portfolio choice decisions by investors and finds that countries' sovereign rating, quality of institutions and their financial exposure are determinants of cross-country differences in the transmission.
Keywords: Advanced Economies; Capital Flows; Emerging Market Economies; Global Financial Crisis; High Dimensional VARs; Liquidity Risk; Sovereign Debt Crisis; Transmission
JEL Codes: C5; E44; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity shocks (E44) | asset prices (G19) |
| risk shocks (D81) | asset prices (G19) |
| liquidity shocks (E44) | capital flows (F32) |
| risk shocks (D81) | capital flows (F32) |
| flight-to-safety phenomenon (G41) | capital outflows from EMEs to AEs (F32) |
| countries' financial exposure to the US (F65) | vulnerability to global shocks (F65) |
| domestic fundamentals (J12) | vulnerability to global shocks (F65) |
| portfolio choices (G11) | correlation between returns and flows for safer assets in AEs (F32) |
| portfolio choices (G11) | correlation between returns and flows for riskier assets in EMEs (F32) |