Cross-country Linkages Research Articles

Vietnam's Long-run Growth: Connecting the Dots through Climate Damage Spillovers

We propose to examine how climate damage may transform Vietnam's long-run growth rate. Because of cross-country linkages forged by bilateral trade, there are two channels through which international damage spillovers may occur. First, the dynamics of partners' growth determine future trends in Vietnam's volume of exports. Second, since the domestic impact of climate change may be heterogeneous across countries, there will be a differentiated impact on export and import market shares. Both terms play a critical role in changing trade patterns that are likely to shift Vietnam's external constraint. This demand-side view of growth based on the balance-of-payments constraint is a powerful predictor of inter-country growth differences. Our study show that the consequences of climate change could equate to a 2.5% reduction in Vietnam's growth rate over the period 2020-2060. Our decomposition exercise by effect and by partner area shows that international damage spillovers result from very different individual behaviours.

Identifying the external and internal drivers of exchange rate volatility in small open economies

This paper estimates a 3-country DSGE model to identify the drivers of exchange rate volatility in small open economies (SOE). In addition to the usual cross-country linkages through trade and asset holdings, the model features common shocks that affect economies symmetrically. Using data from Jamaica, the US and the G-7 region (excluding the US), the paper finds that external financial shocks are the primary drivers of exchange rate fluctuations in the SOE. While domestic financial shocks are bigger contributors than US and G-7 specific shocks, shocks that are common across the US and the G-7 generally play the main role. Nonfinancial shocks, domestic and external, are inconsequential for exchange rate volatility. Inferences from a vector autoregressive model with exogenous variables are consistent with these results.

Should I open to forecast? Implications from a multi-country unobserved components model with sparse factor stochastic volatility

In this paper, we assess whether and when multi-country studies pay off for forecasting inflation and output growth. Factor stochastic volatility is adopted to allow for cross-country linkages and model economies jointly. We estimate factors and rely on post-processing, rather than expert judgement, to obtain an estimate for the number of factors. This is different from most existing two-step approaches in the factor literature. Our approach is then used to extend the existing unobserved components model, which assumes that 34 economies are independent. The results suggest that allowing for cross-country linkages yields inflation and output growth forecasts that are highly competitive with those obtained from estimating economies independently. Zooming into the forecast performance over time reveals that allowing for cross-country linkages is of particular importance when interest centres on forecasting periods of uncertainty. Another key finding is that the estimated global factors are correlated with the domestic business cycle. We interpret this to mean that part of the variation captured in global factors reflects a global business cycle.

Economic Policy Uncertainty: Cross-Country Linkages and Spillover Effects on Economic Development in Some Belt and Road Countries.

With the increase of economic environment uncertainty, it is of great importance to study the linkage and spillover effects of economic policy uncertainty among countries. Especially, this article selects eight countries along the Belt and Road as the core countries (China, Korea, Croatia, India, Russia, Greece, Pakistan, and Singapore) and four countries (Germany, France, Japan, and UK) as the peripheral countries, and then copula technique and mixed-frequency global vector autoregressive model are employed to analyze the correlation and the spillover effect of the economic policy uncertainty (EPU) for the twelve selected countries, respectively. The proposed empirical findings show clearly that the EPU correlation among the eight core Belt and Road countries is stronger and the spillover effect of the core countries to the peripheral countries is statistically significant. As a result, for harmonious and win-win development, the Belt and Road countries should pay a close attention to the EPU, because the stability of the EPU promotes greatly the economy development.

Cross-Country Linkages and Asymmetries of Sovereign Risk Pluralistic Investigation of CDS Spreads

Credit Default Swap (CDS) spread is a realistic measure of credit risk. Changes in the spreads showcase changes in the underlying uncertainty or credit volatility regarding the credit risk, associated with the asset class. We use Multifractal Detrended Fluctuation Analysis (MF-DFA) to further investigate the presence of asymmetries and the difference between Greece and G7 countries in terms of credit risk. We have considered 2587 daily observations for each of the 48 CDS spreads. Hence, a total of 124,176 data points were under consideration across six yearly CDS categories of Greece and most of the G7 countries (Germany, USA, UK, Canada, Japan). The tenure of these CDS were 1 year, 2 years, 3 years, 5 years, 7 years, 10 years, 20 years, and 30 years. We have found that the Greek CDS spread movement is purely stochastic and anti-persistent, having practically no predictability at all. On the other hand, the remaining countries’ CDSs were highly predictable, showing a consistent long memory or long-range dependence, having embedded the bubble caused by herding. This is reflected in terms of flight-to-quality behavior and in estimates of CDS premiums for insurance against a default on government bonds.

Economic policy uncertainty: Persistence and cross-country linkages

This paper provides new evidence on the stochastic behaviour of the EPU (Economic Policy Uncertainty (EPU) index constructed by Baker et al. (2016) in six of the biggest economies (Canada, France, Japan, US, Ireland, and Sweden), and also on cross-country linkages, over the period from January 1985 to October 2019. For this purpose, it uses fractional integration/cointegration methods to measure the degree of persistence of the EPU and whether there exists a long-run equilibrium relationship linking the individual indices. This framework is much more general than the standard approaches based on the I(0)/I(1) dichotomy since it allows for fractional values of the integration/cointegration parameter and therefore does not impose restrictive assumptions on the dynamic behaviour of the individual series and their linkages. EPU is found to be in most cases a non-stationary, mean-reverting series which is characterised by long memory. Several breaks are also detected in each country. Finally, there is very little evidence of cross-country linkages. Our analysis provides fresh insights into the degree of persistence and the transmission of EPU shocks and has implications both for investors having to make risk management decisions and choose investment strategies and policymakers having to design effective macroeconomic policies.

Cross country linkages and transmission of sovereign risk: Evidence from China’s credit default swaps

China’s climb to a trading powerhouse has changed its position in the world and therefore its relationships with other economies. As a result, its sovereign credit risk, which we measure by the pricing of its credit default swaps (CDS), now has the potential to greatly impact other sovereign CDS spreads. Employing a dynamic approach, we find that changes in China’s sovereign risk has strong contagion effects on its goods and service providers, while China is vulnerable to contagion effects from its major importers, suggesting sovereign risk spills over to other regions via the global supply chain. China’s success hurts some of the weaker countries in Europe by competing for their customers, while China faces strong competition itself from its export-focused neighbors. FDI and portfolio investment also affect the CDS relationships between China and other economies.

Economic Policy Uncertainty: Persistence and Cross-Country Linkages

This paper provides new evidence on the stochastic behaviour of the EPU (Economic Policy Uncertainty (EPU) index constructed by Baker et al. (2016) in six of the biggest economies (Canada, France, Japan, US, Ireland, and Sweden) over the period from January 1985 to October 2019. In particular, it uses fractional integration methods to shed light on its degree of persistence, and also carries out appropriate break tests. Further, the possible co-movement of this index between countries is examined applying a fractional cointegration method which tests for the possible existence of a long-run equilibrium relationship linking the individual indices. EPU is found to be in most cases a non-stationary, mean-reverting series which is characterised by long memory. Several breaks are also detected in each country. Finally, there is very little evidence of cross-country linkages.

Tracking the relationship between euro area equities and sovereign bonds

This paper explores the relationship between stocks and sovereign bonds by means of the asymmetric detrended cross-correlation analysis (ADCCA). Drawing on data from 1999.01 to 2018.09 of the first wave of euro area countries, the full sample is divided into three subsets in accordance with economic and financial features. Some findings arise with striking implications for investors and policymakers. Firstly, empirical results show that cross-correlations differ from country to country, depending on the sub-period under analysis and on the time scale. Secondly, likewise within country estimates, cross-country linkages may point to fragmentation in the euro area with agents moving away from financial assets of lower-rated countries to invest in more robust economies in periods of turmoil. Thirdly, there is evidence of asymmetry since 'flight-to-quality' movements seem to be more relevant than 'flight-to-yield' episodes. Finally, while relationships were globally bidirectional until mid-2007, new causality patterns arose with the financial crisis.

Cross-Country Linkages and Spill-Overs in Early Warning Models for Financial Crises

This paper uses data on bilateral foreign exposures of domestic banking systems in order to construct early warning models for financial crises that take into account cross-country spill-overs of vulnerabilities. The empirical results show that incorporating cross-country financial linkages can improve the signalling performance of early warning models. The relative usefulness increases from 65% to 87% and the AUROC from 0.89 to 0.97 when weighted foreign variables are added to domestic variables in a multivariate logit early warning model. The findings of the paper also suggest that global variables still play a role in predicting financial crises, even when foreign variables are controlled for, which could suggest that both cross-country spill-overs and contagion are important factors for driving financial crises. A parsimonious model with nine variables that combines domestic, foreign and global variables yields an out-of-sample relative usefulness of 0.82 with Type I and Type II errors of 0.11 and 0.07. JEL Classification: G01, G17, F37, F65

Финансовое заражение: трансграничное распространение системного риска

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.

Stock-Bond Co-Movements and Cross-Country Linkages

This study analyzes the correlation of stock and bond indices for eight developed countries. We compare a country's stock-bond linkages with cross-country linkages and find that the former exhibit a negative trend in contrast to the positive trend observed for cross-country stock market and bond market linkages. We show that the decline of the stock-bond correlation in recent years can be explained with a more frequent portfolio rebalancing of investors due to the globalization of securities markets and implied lower international diversification benefits across similar asset classes. A test for temporal commonalities of changes in cross-country and stock-bond linkages indicates that flight-to-quality from stocks to bonds and cross-country stock market contagion occurs simultaneously.

Contagion: A Brief Survey of Recent Models in International Finance Literature

Due to intensified economic globalization, cross-country linkages have become the channel through which country-specific shocks may affect financial conditions and macroeconomic variables across borders. Since financial crises of 1990s, crisis propogation has become a contentious issue. Especially after the recent global financial crisis, contagion has attracted considerable attention both from the academia and policymakers. This survey investigates recent model-based approaches on contagion in international finance literature.

A Global Projection Model for Euro Area Large Economies

The GPM project is designed to improve the toolkit for studying both own-country and cross-country linkages. This paper creates a special version of GPM that includes the four largest Euro Area (EA) countries. The EA countries are more vulnerable to domestic and external demand shocks because adjustments in the real exchange rate between EA countries occur more gradually through inflation differentials. Spillovers from tight credit conditions in each EA country are limited by direct trade channels and small confidence spillovers, but we also consider scenarios where banks in all EU countries tighten credit conditions simultaneously.

Cross-country linkages as determinants of procyclicality of loan loss provisions

Procyclicality in banking may result in financial instability and therefore be destructive to economic growth. The sensitivity of different banking balance sheet and income statement variables to the business cycle is diversified and may be prone to increasing integration of financial markets. In this paper, we address the problem of the influence of financial integration on the transmission of economic shocks from one country to another and consequently on the sensitivity of loan loss provisions (LLPs) to the business cycle. The application of the seemingly unrelated regression equations (SURE) approach to 13 OECD countries in 1995–2009 shows that the procyclicality of LLPs is statistically significant almost in the whole sample of countries. Regardless of the econometric specification, the income-smoothing, capital management and risk management hypotheses are hardly supported by the data. However, in SURE specification, the relationship of bank-specific variables is of higher statistical significance than in the country regression approach. Hence, cross-country interconnectedness is not only economically, but also empirically important when analyzing cross-country diversifications of LLPs.

Cross Country Linkages as Determinants of Procyclicality of Loan Loss Provisions Empirical Importance of Sure Specification

Procyclicality in banking may result in financial instability and therefore be destructive to economic growth. The sensitivity of different banking balance sheet and income statement variables to the business cycle is diversified and may be prone to increasing integration of financial markets. In this paper we address the problem of the influence of financial integration on the transmission of economic shocks from one country to another and consequently on the sensitivity of loan loss provisions to the business cycle. We also aim to find out whether earnings management hypotheses are supported throughout the whole business cycle. Application of the SURE approach to 13 OECD countries in 1995-2009 shows that the procyclicality of LLP is statistically significant almost in the whole sample of countries. Independent of the econometric specification, the earnings management hypotheses are hardly supported.

China's financial linkages with Asia and the global financial crisis

This paper presents empirical evidence on asset market linkages between China and Asia and how these linkages have shifted during and after the global financial crisis of 2008–2009. We find only weak cross-country linkages in longer-term interest rates, but much stronger linkages in equity markets. This finding is consistent with the greater development and liberalization of equity markets relative to bond markets in China, as well as increasing business and trade linkages in the region. We also find that the strength of the correlation of equity prices changes between China and other Asia countries increased markedly during the crisis and has remained high in recent years. We attribute this development to greater “attentiveness” of international investors to China's role as a source and destination of equity finance during the crisis rather than to any greater financial deepening and liberalization, as China did not implement any major policy measures during this period. By contrast, the transmission of U.S. equity returns to Asian countries decreased after the crisis.

China’s Financial Linkages with Asia and the Global Financial Crisis

This paper presents empirical evidence on asset market linkages between China and Asia and how these linkages have shifted during and after the global financial crisis of 2008-2009. We find only weak cross-country linkages in longer-term interest rates, but much stronger linkages in equity markets. This finding is consistent with the greater development and liberalization of equity markets relative to bond markets in China, as well as increasing business and trade linkages in the region. We also find that the strength of the correlation of equity prices changes between China and other Asia countries increased markedly during the crisis and has remained high in recent years. We attribute this development to greater “attentiveness” of international investors to China’s role as a source and destination of equity finance during the crisis rather than to any greater financial deepening and liberalization, as China did not implement any major policy measures during this period. By contrast, the transmission of U.S. equity returns to Asian countries decreased after the crisis.

GPM6: The Global Projection Model with 6 Regions

This is the sixth of a series of papers that are being written as part of a project to estimate a small quarterly Global Projection Model (GPM). The GPM project is designed to improve the toolkit to which economists have access for studying both own-country and cross-country linkages. In this paper, we add three more regions and make a number of other changes to a previously estimated small quarterly projection model of the US, euro area, and Japanese economies. The model is estimated with Bayesian techniques, which provide a very efficient way of imposing restrictions to produce both plausible dynamics and sensible forecasting properties.

Cross-Country Linkages in Europe: A Global VAR Analysis

This paper uses the Global VAR (GVAR) model proposed by Pesaran et al. (2004) to study cross-country linkages among euro area countries, other advanced European countries (including the Nordics, the UK, etc.), and the Central, Eastern and Southeastern European (CESEE) countries. An innovative feature of the paper is the use of combined trade and financial weights (based on BIS reporting banks’ external position data) to capture the very close trade and financial ties of the CESEE countries with the advanced Europe countries. The results show strong co-movements in output growth and interest rates but weaker linkages bewteen inflation and real credit growth within Europe. While the euro area is the dominant source of economic influences, there are also interesting subregional linkages, e.g. between the Nordic and the Baltic countries, and a small but notable impact of CESEE countries on the rest of the Europe.