Global Risk Appetite Research Articles

Reprint of “Unveiling the dance of commodity prices and the global financial cycle”

We examine the impact of commodity price changes on the business cycles and capital flows in emerging markets and developing economies (EMDEs), distinguishing between their role as a source of shock and as a channel of transmission of global shocks. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP, an effect further amplified by the endogenous decline of country spreads. However, the effects on capital flows appear muted. Shifts in U.S. monetary policy and global risk appetite drive the global financial cycle in EMDEs. Eased global credit conditions, attributed to looser U.S. monetary policy or lower global risk appetite, lead to a rise in export prices, higher output, a decrease in government borrowing costs, and stimulate greater capital flows. The endogenous response of export prices amplifies the output effects of a more accommodative U.S. monetary policy while country spreads magnify the impact of shifts in global risk appetite.

Unveiling the dance of commodity prices and the global financial cycle

We examine the impact of commodity price changes on the business cycles and capital flows in emerging markets and developing economies (EMDEs), distinguishing between their role as a source of shock and as a channel of transmission of global shocks. Our findings reveal that surges in export prices, triggered by commodity price shocks, boost domestic GDP, an effect further amplified by the endogenous decline of country spreads. However, the effects on capital flows appear muted. Shifts in U.S. monetary policy and global risk appetite drive the global financial cycle in EMDEs. Eased global credit conditions, attributed to looser U.S. monetary policy or lower global risk appetite, lead to a rise in export prices, higher output, a decrease in government borrowing costs, and stimulate greater capital flows. The endogenous response of export prices amplifies the output effects of a more accommodative U.S. monetary policy while country spreads magnify the impact of shifts in global risk appetite.

Practical Applications of Tactical Asset Allocation, Risk Premia, and the Business Cycle: A Macro Regime Approach

In <b><i>Tactical Asset Allocation, Risk Premia, and the Business Cycle: A Macro Regime Approach</i></b>, from the March 2023 issue of <b><i>The Journal of Portfolio Management</i></b>, <b>Alessio de Longis</b> and <b>Dianne Ellis</b> of <b>Invesco</b> propose a tactical asset allocation methodology based on identifying key phases of the business cycle and tilting portfolios toward risk premiums that outperform during each phase. They provide a rules-based approach for predicting phases of the business cycle based on leading economic indicators and the global risk appetite. They focus on three risk premiums as the key elements for implementing the methodology: the term premium, the credit premium, and the equity premium. The authors demonstrate the use of their methodology with multiasset and fixed-income portfolio examples. The examples show a potential to generate excess returns, compared to a buy-and-hold benchmark, while maintaining an equivalent level of risk over the long term.

Cryptocurrency and Innovation: The Relationship with Technology in Light of Risk Aversion and Market Sentiment

The paper performs a (Panel) Moderated Regression, Causality and Cointegration (complete version) test on the relationship between the exchange rate of major selected cryptocurrencies vs. major fiat currencies, and selected technology indices of various geographic areas and economic groups in the world, representative of different countries or areas in the world (Europe) and for different levels of market capitalization. The dataset allows to focus on the comparison pre- and post-Covid19 (complete version), testing the relationship in those two different time frames. The novelty of the study is the use of risk aversion and VIX volatility index (market sentiment) as control variables. Various indices of risk aversion have been developed, presenting different levels of trade-off in terms of availability (ease of calculation) and effectiveness. A good candidate seems to be the Global Risk Appetite Index (GRAI) by Kumar and Persaud (2002). As for the VIX index, it has been widely used as a proxy of market sentiment, but rarely applied to the understanding of currency trends (especially cryptocurrency). Our expectation is to observe some significant moderation effect for some of the indicators considered, in general and when observing the data for different sub-periods. with investors probably trying to hedge equity investments and diversify their portfolios differently, with risk aversion and VIX index to be a driving factor of those choices. We also expect results to be confirmed by the Causality and Cointegration (complete version) test. The paper aims to contribute to the Fintech literature and shed light on the possibilities of diversification offered by tech-related portfolios. As a corollary, it aims to determine how the effect of risk aversion and general market risk sentiment drives those choices. Keywords: Cryptocurrency; Technology Index; Risk Appetite; Market Sentiment; Causality; Cointegration; Panel Regression.

Tactical Asset Allocation, Risk Premia, and the Business Cycle: A Macro Regime Approach

Market conditions change over the course of the business cycle. When are investors compensated to take risk? And what type of risk? We propose a practical regime-based framework for tactical asset allocation (TAA), combining leading economic indicators and global risk appetite to identify four macro regimes: recovery, expansion, slowdown, and contraction. We document distinct performance characteristics across regimes for traditional asset classes and their underlying risk factors, focusing on the term premium, credit premium, and equity premium. We provide simple and practical examples of TAA strategies for long-only multi-asset, and fixed income portfolios with the potential to generate attractive excess returns. Results are statistically significant and economically relevant after transaction costs, with information ratios between 0.70 and 0.80.

Empirical Analysis of the Relationship of Stock Market, Exchange Rate, CDS Spreads and VIX Index in Turkey

Küresel entegrasyon süreçlerinin hız kazanmasıyla yaşanan krizlerin yapısındaki ortak noktanın genel olarak ülke risk primindeki artışlar veya büyük açık ekonomilerde ortaya çıkan oynaklıkların olduğu görülmektedir. Bu çalışmanın amacı Türkiye’de borsa endeksi, döviz kuru, risk primi (CDS) ve korku endeksi (VIX) arasındaki ilişkileri incelemektir. Bunun için ARDL sınır testinden yararlanılmıştır. Analiz dönemi olarak hem veri bulunabilirliği açısından hem de Türkiye ekonomisi için yapısal bir dönüm noktası olan Şubat 2001 sonrası dönem kullanılmıştır. Literatürden farklı olarak hem ülke risk primini temsil eden CDS primi, hem de yurtdışı risk alma iştahını ve dolayısıyla yurtdışı konjonktürü yansıtan VIX endeksi aynı modelde kullanılmıştır. Bu şekilde CDS ve VIX göstergelerinin aynı modelde kullanılması sonucunda borsa endeksi üzerindeki etkilerinin aynı düzeyde olup olmadığı sorusuna ışık tutulmaya çalışılmıştır. Elde edilen ampirik bulgulara göre Türkiye’de borsa endeksini döviz kuru, CDS primi ve VIX endeksi etkilemektedir. Küresel piyasalara entegre bir ülke olan Türkiye’de bu sonucun beklentiler dahilinde düşünülmektedir. Yani döviz kuru, ülke risk primi ve yurtdışı risk alma iştahında meydana gelen değişimlerin borsa hareketleri üzerinde etkisi bulunmaktadır. Sonuçlarımız, küresel risk alma iştahını temsilen VIX endeksine kıyasla ülke riskini temsil eden CDS priminin BİST 100 için önemli bir gösterge olduğunu göstermektedir. Bu durumda hisse senedi piyasalarında incelenen değişkenlerin önemini öne çıkarmaktadır.

Exchange Rate Reconnect

Abstract It is surprisingly difficult to find economic variables that strongly comove with exchange rates, a phenomenon codified in a large literature as “exchange rate disconnect.” We demonstrate that a variety of common proxies for global risk appetite, which did not comove with exchange rates prior to 2007, have provided significant in-sample explanatory power for currencies since then. Furthermore, during the 2007–2012 period, U.S. purchases of foreign bonds were highly correlated with these risk measures and with exchange rates. Our results support the narrative that the U.S. dollar's role as an international and safe-haven currency has surged since the global financial crisis.

A closer look into the behavior of emerging market sovereign spreads: State-dependent and asymmetric behaviors

We analyze state-dependent and asymmetric behavior of emerging market (EM) sovereign bond spreads in response to changes in global risk appetite and liquidity. We use dynamic Markov-switching, fixed-effect panel threshold, and time-varying causality analyses along with our research setting. Empirical results provide evidence for both state-dependent and asymmetric behavior of EM sovereign spreads. We also find that these behaviors became even more pronounced after the global financial crisis (GFC). EM external debt markets display more sensitivity to good news in the post-GFC era. Global liquidity's impact on EM sovereign spreads displays a more complicated dynamic than the global risk appetite.

How the macroeconomic conditions and the global risk factors affect sovereign CDS spreads? New Evidence from Turkey

This paper aims to investigate the effects of a set of major country-specific macroeconomic variables and global risk factor on determining Turkey’s sovereign CDS spreads. The industrial production index, consumer price index, nominal exchange rates, policy interest rate, stock market index, and the volatility index as a proxy for global risk appetite are used by employing SVAR methodology with block exogeneity for 2011M01-2020M09 periods. The results reveal that the country's nominal exchange rate is the main driver of sovereign CDS spread. Especially in 2018, the most significant source of the high increase in sovereign CDS spreads is the exchange rates. According to the impulse response functions, to reduce the sovereign CDS spread, economic growth is more effective than the stock market return. Moreover, it is seen that the global risk factor does not play an essential role in the increases in domestic country's sovereign CDS spread.

Determinants of and Prospects for Market Access in Frontier Economies

In recent years, we have observed an increase in low-income countries’ (LICs) access to international capital markets, especially after the Global Financial Crisis (GFC). This paper investigates what factors—country-specific macroeconomic fundamentals and/or external variables—have contributed to the surge in external bond issuance by these LICs, which we refer to in our paper as ‘frontier economies’. Using data on public and publicly guaranteed (PPG) external bond issuance, outstanding PPG bond stock, as well as sovereign spreads, we employ panel data analysis to examine factors related to the increase in issuance by these economies as well as the reduction in their spreads over time. Our empirical study shows that both country-specific fundamentals (such as public debt, current account balance, level of reserves, quality of institutions) and external variables (such as US growth and the VIX index) play a role in explaining the increased amount of issuance and the decline in spreads of frontier economies’ sovereign bonds. The impact of some of these variables on issuance appears to reflect a country’s need to issue bonds for external financing (‘the supply side’ of bond issuance), while others appear to correlate more through their impact on investors’ appetite for a country’s debt (‘the demand side’). In addition, the impact of country-specific variables can also be affected by external factors such as global risk appetite. Our analysis of key factors that have contributed to increased market access for frontier economies over the past decade provides important information to gauge the prospects for their continued market access, and for other LICs to join this group by tapping international markets for the first time.

A SYSTEM DYNAMIC APPROACH FOR DETERMINATION OF OPTIMAL MONETARY POLICY DURING THE COVID-19 ECONOMIC CRISIS: A CASE OF TURKEY

Starting from mid-March 2020, Covid-19 outbreak spread across the world, the implementation of the social distance and closing the country borders led to the shutdown of economic activities and bring uncertainties for financial markets. Uncertainties have caused a decrease in global risk appetite and resulted to important portfolio outflows from emerging countries. In this process CBRT has started to adopt monetary expansion measures through rate cuts asset purchases to stimulate the financial markets. In this context, this article aims to explore the effects of expansionary monetary policies of CBRT on economic growth, inflation and financial stability in Turkey with a holistic approach. Using a dynamic model, two scenarios were developed covering the period from January 2010 to May 2020. In the first scenario, when monetary expansion policy is implemented, it is assumed that the policy rate and required reserves will not change, but a growth-oriented policy will continue. In the second model, a tight monetary policy, foreign capital inflow and, if necessary, a foreign currency intervention scenario was designed. It was observed that an expansionary monetary policy scenario that is not based on external resources did not fully realize the expected economic recovery. The findings obtained in the second scenario are more effective than the first scenario. Besides that, the second scenario is found more effective on growth, inflation and financial stability.

Global liquidity, global risk appetite, and the risk of credit and asset booms

This study examines the channels through which net cross-border bank flows and VIX, working through the domestic banking system, could potentially lead to the creation or exacerbation of credit and asset booms that may threaten financial stability. It uses bank firm-level data for the Philippines over the period 1991-2018. Among the study’s significant findings are the following: bank lending to the real estate and housing sector is consistently and significantly affected by net cross-border bank flows (NCBF); non-core bank liabilities is an important variable as it consistently affects the amount of total loans and loans to the commercial and industrial sector as well as bank asset growth and bank leverage; net cross-border flows lower bank asset growth; and banks’ cost of loans tends to be reduced by NCBF and by a reduction in global risk appetite. The use of macroprudential measures-including monitoring bank non-core liabilities and lending to sectors such as real estate-as well as capital flow management measures is warranted in order to prevent bank credit and asset booms from being created or exacerbated, which may threaten growth and financial stability.

Assessing the price dynamics of onshore and offshore RMB markets: An ITS model approach

This paper investigates how the price dynamics of both onshore and offshore RMB markets are affected by fundamental determinants, market liquidity, global risk aversion and policies by using daily data from August 2010 to February 2016. The interval time series (ITS) modelling is applied to study the RMB price mechanism by capturing prices of the two markets as one self-formed interval data. An interval-based Wald test is constructed to examine the differences between the coefficients and an interval-based Mallows criterion is proposed for choosing appropriate explanatory variables. We find that both the price level and the price differences of onshore and offshore RMB markets are greatly affected by economic fundamentals indicated by different returns on stock indexes and market liquidity indicated by bid-ask prices of offshore market price. In addition, it is suggested that the interest rate spread between China and the US and the global risk appetite do not significantly affect the RMB price for both onshore and offshore markets. Finally, the results imply that “811 reform” of the RMB exchange rate regime does not change the fundamental price dynamics of RMB markets, but significantly changes how economic fundamentals affect the price mechanism of RMB exchange rate.

Global and Local Currency Effects on Euro Area Investment in Emerging Market Bonds

We analyze how global and local factors affect portfolio allocation by euro area investors in emerging markets at the bond-level. First, cross-sectional analysis reveals a strong preference for home (Euro) currency bonds. Second, panel regressions, whether at the bond or aggregate flows level, consistently identify trade-weighted US dollar fluctuations as the most robust explanatory variable, in sharp contrast to other global factors, such as the VIX and Fed or ECB monetary policy, which have much less impact on reallocations to emerging market bonds. Our results are consistent with the notion that broad US dollar movements act as a barometer for global risk appetite, but with an important caveat: Throughout our analysis we find holdings in Euro-denominated bonds are less sensitive to global factors, which we interpret as further evidence of a home currency bias.

The volatility spillover effects among risk appetite indexes: insight from the VIX and the rise

This study aims to test the volatility spillover effects among the global risk appetite, the VIX (also known as the fear index) and the RISE index (known as the indicator of investor risk appetite index in Turkey). A temporary or permanent causality Granger and Breitung Candelon (Breitung and Candelon in J Econom 132(2):363–378, 2006) frequency domain causality analyses were performed by using the weekly dataset spanning from January 2010 to December 2018. The results obtained from the study reveals a unilateral causal relationship running from the VIX toward the RISE index. This causality inference is also observed separately in the short-, medium- and the long-run. Consequently, the investigation found that there is a permanent causal relationship running from the VIX toward the RISE index. These results also indicate the existence of the volatility spillover effect among the risk appetite indexes. Consequently, the current study offers significant policy directives from the side of the government and other stakeholders especially that are targeted at mitigating fear factors in the economy.

VIX KORKU ENDEKSİNİN FİNANSAL GÖSTERGELER ÜZERİNDEKİ ETKİSİ: TÜRKİYE ÖRNEĞİ

Küresel risk iştahının göstergesi olarak kabul edilen VIX endeksi bir çok ülkenin finansal yapıcıları tarafından takip edilmektedir. Çünkü VIX endeksinden meydana gelen değişimler ulusal piyasalardaki bir çok finansal göstergeyi de etkilemektedir. Bu bağlamda çalışmanın amacı VIX endeksinin Türkiye’deki çeşitli finansal göstergeler üzerinde bir etkisinin olup olmadığı hem Granger (1969) nedensellik analizi hem Breitung ve Candelon frekans nedensellik analizi hem de Johansen eşbütünleşme analizi ile test etmektir. Granger nedensellik analizi sonucunda VIX endeksindeki değişimin, BİST 100 endeksi, Dolar ve Euro kuru, sanayi üretim endeksi, reel kesim ve tüketici güven endeksi, satın alma yöneticileri endeksi ve risk iştahı endeksindeki değişimlerin nedeni olduğu tespit edilmiştir. Frekans nedensellik analizi sonuçlarına göre ise VIX endeksindeki değişimden BİST 100 endeksi, Dolar ve Euro kuru, faiz oranı, sanayi üretim endeksi, reel kesim güven endeksi, satın alma yöneticileri endeksi ve risk iştahı endeksindeki değişime doğru nedenselliğin kalıcı, tüketici güven endeksindeki değişime doğru nedenselliğin ise geçici olduğu tespit edilmiştir. Eşbütünleşme analizine göre ise VIX ile ilgili değişkenler arasında uzun dönemli bir ilişki olduğu tespit edilmiştir.

Time-Series Variation in Factor Premia: The Influence of the Business Cycle

Factor cyclicality can be understood in the context of factor sensitivity to aggregate cash-flow news. Factors exhibit different sensitivities to macroeconomic risk, and this heterogeneity can be exploited to motivate dynamic rotation strategies among five commonly established factors: size, value, quality, low volatility and momentum. A timely and realistic identification of business cycle regimes, using leading economic indicators and global risk appetite, can be used to construct long-only factor rotation strategies with information ratios nearly twice as large as static multifactor strategies. Results are statistically and economically significant after accounting for transaction costs, capacity and turnover.

Local currency bond risk premia: A panel evidence on emerging markets

This paper investigates the sources of variation in emerging market (EM) local currency bond risk premium. We find that macroeconomic and financial variables contain valuable information in explaining local currency bond excess returns. Additionally, we extend our analysis to investigate how the influence of different factors change depending on the level of global risk appetite. Although macro fundamentals have an important role in explaining the risk premiums during tranquil times, investors pay less attention to changes in inflation forecast in times of high risk aversion. Positive credit rating changes decrease the bond risk premium in both regimes with a different magnitude. Also, the influence of exchange rate volatility is more pronounced during the time of market stress.

Exchange Rate Reconnect

It is surprisingly difficult to find economic variables that strongly co-move with exchange rates, a phenomenon codified in a large literature on “exchange rate disconnect.” We demonstrate that a variety of common proxies for global risk appetite, which did not co-move with exchange rates prior to 2007, have provided significant in-sample explanatory power for currencies since then. Furthermore, during 2007-2012, U.S. purchases of foreign bonds were highly correlated with these risk measures and with exchange rates. Our results support the narrative that the US dollar's role as an international and safe-haven currency has surged since the global financial crisis.

On corporate borrowing, credit spreads and economic activity in emerging economies: An empirical investigation

We document a considerable increase in foreign financing by the corporate sector in emerging economies (EMEs) since the early 2000s, mainly in the form of bond issuance, and claim that it has opened up an important channel by which external financial factors can drive economic activity in these economies. Such claim is substantiated by a strong negative relationship between economic activity and an external financial indicator that we construct for several EMEs using micro-level data on spreads of bonds issued by EMEs' corporations in foreign capital markets. Three salient features characterize such a negative relationship. First, the financial indicator has considerable predictive power on future economic activity in these economies, even after controlling for other potential drivers of business cycles such as movements in sovereign spreads and global financial risk, among others. Second, on average, an identified adverse shock to the financial indicator generates a large and protracted fall of real output growth in these economies, and up to 14% of its forecast error variance is associated to this shock. Lastly, fluctuations in this indicator also respond strongly to shocks in global financial risk emanating from world capital markets, thereby implying that changes in corporate spreads also serve as a powerful propagating mechanism of the effect of changes in global investors' risk appetite in emerging markets.