Abstract
This paper shows that signals from the offshore Hong Kong, China spot market for the currency of the People’s Republic of China (PRC), the renminbi (listed as CNH), directly affect the volatility of share prices of PRC banks and the overall risks to banking stability in the country. This is especially so amid heightened uncertainty about global trade of the PRC. Thus, CNH market volatility is a leading indicator of onshore PRC banking sector volatility. The results suggest that further offshore exchange market movements arising out of news such as increasing trade friction with the United States will generate greater volatility in the PRC’s banking sector. Far from being a shock absorber for the financial system of the PRC, the CNH market appears to be a shock transmitter of risk from offshore economic policy uncertainty to the PRC’s banking system.
Highlights
This research examines the linkages between offshore fears—captured by movements in Economic Uncertainty indices, compiled by Baker, Bloom, and Davis (2016)—and onshore financial market risks in the People’s Republic of China (PRC), captured by the realized daily range volatility of PRC banks
We find that the key transmission channel of offshore fears to onshore banking sector risk and risk contagion is the Hong Kong, China-based spot market for the renminbi (RMB), CNH
The results of this paper show the way offshore fears—signaled by volatility in the CNH Hong Kong, China spot market for the RMB-United States (US) dollar or by spreads between the offshore and onshore RMB markets—have become increasingly important sources of risk contagion for PRC banks
Summary
This research examines the linkages between offshore fears—captured by movements in Economic Uncertainty indices, compiled by Baker, Bloom, and Davis (2016)—and onshore financial market risks in the People’s Republic of China (PRC), captured by the realized daily range volatility of PRC banks. Using lower-frequency data, Gu and McNelis (2013) find that the offshore CNH market was a key channel for transmitting volatility contagion effects from the yen per dollar spot market to onshore PRC financial markets, in the onshore RMB per dollar spot market and the overall share price index. They did not consider the share price volatility of PRC banks. Funke et al (2015) did not examine the effects of these differentials on banking sector stability in the PRC, and how this market may be affected by bank share price volatility in the PRC or global measures of economic policy uncertainty. For the PRC, the peak value of uncertainty was in December 2018, when two Canadian citizens were detained in the PRC
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