Abstract
The article studies financial shock transmission mechanisms and cross-country linkages that make it possible. Given increased interconnections around the globe there is general agreement that in recent time financial system has become much more vulnerable to exogenous shocks. The main channels of transmission are trade and financial linkages among nations. The former are more traditional for developing countries while the latter – for developed markets. The appetite of global investors to risk, the level of uncertainty and information asymmetry in the global financial market are also important factors which can influence the magnitude of shock transmission. The article gives an overview of different methods to calculate the risks of financial shock transmission across countries including correlation and volatility analysis, contingent claims analysis, econometric models with a global factor and different types of VAR (VEC). Using the method of forecast error variance decomposition from a vector auto regression, first proposed by F. Diebold and K. Yilmaz to analyze stock markets interconnectedness, the author quantifies directions of financial shock spillovers in equity, government bond and real estate markets. This methodology was applied to 10 countries. It was found that US, Germany and France are the major transmitters of shocks to other countries. The results point to a slight difference in the magnitude of transmission in different sectors: stock markets tend to suffer more from spillover effects while government bond markets are more sensitive to internal factors of instability. The article also discusses various approaches to global systemic risk modeling which is a new area of research in recent time. Regulatory reforms which began in the post-crisis period are considered to be a necessary condition to decrease the intensity of financial shocks transmission. Taking into account how fast the shocks spillover across countries, recovery from the recession requires in the first place coordinated policy actions among governments.
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