Abstract
The global financial crisis of 2008-2009 illustrates how financial turmoil in advanced economies could trigger severe financial stress in emerging markets. Previous studies dealing with financial crises and contagion show the linkages through which financial stress are transmitted from advanced to emerging markets. This paper extends the existing literature on the use of financial stress index (FSI) in understanding the channels of financial transmission in emerging market economies. Using FSI of 25 emerging markets, our panel regression estimates show that not only advanced economies FSI, but also regional and nonregional emerging market FSIs significantly increase domestic financial stress. Our findings also suggest that there is a common regional factor significantly affecting domestic FSI in emerging Asia and emerging Europe. Furthermore, the results from a structural vector autoregression model with contemporaneous restrictions indicate that although a domestic financial shock still accounts for most of the variation in domestic FSI, regional shocks play an important role in emerging Asia.
Highlights
The recent global financial crisis demonstrates the adverse effects of financial globalization
The analysis includes financial stress index (FSI) in various economic and geographic groupings of the countries to understand the transmission of financial shock from these different groups
Earlier studies indicated that financial shocks spread from advanced to emerging market economies
Summary
The recent global financial crisis demonstrates the adverse effects of financial globalization. This paper employs two methodologies for constructing domestic FSI for each emerging market in the sample—one is the variance-equal weights and the other is the principal component analysis This will allow for robustness checks on the overall patterns of individual FSIs. Third, this study assesses the impact of external financial shocks on domestic FSI by differentiating their economic and geographic origins, such as advanced versus emerging market economies as well as regional versus nonregional emerging market economies. Fourth, following the panel regression analysis for the magnitude and significance of advanced and other regional and nonregional emerging market FSI on domestic FSI, we will employ impulse response functions and variance decompositions to assess the impact of a financial shock coming from advanced and other emerging market economies on individual emerging market economies’ FSI.
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