Large Negative Shocks Research Articles

Tail risk spillovers between Islamic sectoral equities and bond markets: a time-frequency domain approach

ABSTRACT This study examines the tail risk spillover between Islamic sectoral stock indices and country specific investable Islamic bonds in time and frequency domain and provides useful implications for portfolio management. For the analyses, Conditional Autoregressive ValueatRisk (CAViaR), Quantile Connectedness, and DCCGARCH t-Copula models are estimated utilizing daily data from 15 countries. The findings show that the connectedness and spillover of risks are much stronger at tails than at median, and in the short-term than in long-term. Whereas median risk connectedness surges during COVID-19 pandemic, the connectedness between tail risks is usually elevated even before the COVID-19 pandemic with industrial sector being consistently a significant net transmitter of shocks. Moreover, all the sectoral stock market indices are significant and consistent transmitter of left tail shocks indicating a much stronger role of sectoral stock markets in transmitting large negative shocks. A heightened connectedness is also observed during Russia-Ukraine war mainly in the short-term frequency. The portfolio analysis shows that long positions in sectoral stocks can usually be hedged by taking short positions in Islamic bonds. Hedging effectiveness and optimal portfolio weights are also calculated to provide market participants with further information.

The effects of heterogeneous CSR on corporate stock performance: evidence from COVID-19 pandemic in China

AbstractCorporate social responsibility (CSR) could be an effective risk-alleviating tool for companies. However, an important issue is whether CSR plays a risk-alleviating role in large negative shocks such as the COVID-19 pandemic. This study investigated the impact of corporate social responsibility on stock performance in China during the COVID-19 pandemic, focusing on the differing effects of strategic and responsive CSR. By analysing daily data on newly confirmed COVID-19 cases and the stock performance of A-share listed companies during the lockdown period in 2020, we find that CSR can significantly mitigate the negative effects of the pandemic on stock returns and recovery. Specifically, responsive CSR has a significant short-term moderating effect, whereas strategic CSR has a significant long-term moderating effect. The moderating effects of CSR are more pronounced among non-state-owned firms, firms with lower financial leverage, and large companies. These findings suggest that companies can reduce short- and long-term risks by strategically using responsive and strategic CSR in response to negative shocks in global economies.

Trust and monetary policy

AbstractWe analyze how trust affects the transmission of negative demand and supply shocks using a behavioral macroeconomic model. We define trust to have two dimensions: trust in the central bank's inflation target and trust in the central bank's capacity to stabilize the business cycle. We find, first, that when large negative shocks occur, the subsequent trajectories taken by output gap and inflation typically coalesce around a good and a bad trajectory. Second, these good and bad trajectories are correlated with movements in trust. In the bad trajectories, trust collapses, and in the good trajectories, it is not affected. This feature is stronger when a negative supply shock occurs than in the case of a negative demand shock. Third, initial conditions, in particular the initial state of inflation and output expectations, matter. Unfavorable initial expectations drive the economy into a bad trajectory, and favorable initial expectations produce good trajectories. Fourth, we analyze the sensitivity of our results with respect to the size of the shocks. Fifth, we derive implications of our results for our capacity of making forecasts about the effects of large demand and supply shocks.

Electoral Violence and Supply Chain Disruptions in Kenya's Floriculture Industry

Abstract Violent conflicts, particularly at election times in Africa, are a common cause of instability and economic disruption. This paper studies how firms react to electoral violence using the case of Kenyan flower exporters during the 2008 postelection violence as an example. The violence induced a large negative supply shock that reduced exports primarily through workers' absence and had heterogeneous effects: larger firms and those with direct contractual relationships in export markets suffered smaller production and loss of workers. On the demand side, global buyers were not able to shift sourcing to Kenyan exporters located in areas not directly affected by the violence or to neighboring Ethiopian suppliers. Consistent with difficulties in ensuring against supply-chain risk disruptions caused by electoral violence, firms in direct contractual relationships ramp up shipments just before the subsequent 2013 presidential election to mitigate risk.

FUTURES PRICES LINKAGES IN THE US SOYBEAN COMPLEX

This work investigates the linkages among the futures prices of soybeans, soybean meal, and soybean oil in the US. This has been pursued using a flexible methodology that allows modelling price relationships at different parts of their joint distribution. According to the empirical results, the markets are strongly connected in the vertical direction regardless of the sign and the size of shocks. The meal and oil prices maintain a negative relationship at the median and the upper quantiles but they are not connected under large negative shocks. The soybean market is a net transmitter of price risk to the other two markets while price shocks around the median tend to be transmitted with higher intensity relative to those at the extremes.

Asymmetric impact of multifarious exchange rate shocks on stock prices: Fresh insights from multiple thresholds nonlinear autoregressive distributed-lag approach

ABSTRACT Exchange rate extreme shocks affect stock prices differently, depending on the sign and the magnitude of changes. This study, therefore, examines the asymmetric impact of multifarious exchange rate shocks on stock prices in sub-Saharan Africa between 1 March 2013 and 14 January 2023, using the novel, multiple thresholds nonlinear autoregressive distributed-lag (MTNARDL) model. This model estimates the effects of extremely small and extremely large positive and negative shocks in exchange rate on stock prices. The study partitioned the sample into pre-COVID-19 and COVID-19 era. The study’s outcome indicates: first, exchange rate shocks below 25th percentile affect stock prices positively but above the 25th percentile and below the upper quantiles (75th percentile) the effects is mixed; second, at the upper quantiles (75th percentile), both exchange rate depreciation and appreciation adversely affect the value of stocks; third, the link between the series is highly sensitive to global shocks; fourth, causality result upholds the flow-oriented model in four out of the six countries. The policy implications are: (i) the responses of stock prices to exchange rates changes are sensitive to the sign and size of the shock, as well as sensitive to global shocks. Consequently, specific policy recommendations have been suggested.

Tail Risk in Production Networks

This paper describes the response of the economy to large shocks in a nonlinear production network. A sector's tail centrality measures how a large negative shock transmits to GDP, that is, the systemic risk of the sector. Tail centrality is theoretically and empirically very different from local centrality measures such as sales share—in a benchmark case, it is measured as a sector's average downstream closeness to final production. It also measures how large differences in sector productivity can generate cross‐country income differences. The paper also uses the results to analyze the determinants of total tail risk in the economy. Increases in interconnectedness can simultaneously reduce the sensitivity of the economy to small shocks while increasing the sensitivity to large shocks. Tail risk is related to conditional granularity, where some sectors become highly influential following negative shocks.

Bank capital shortfall in the euro area

We quantify the bank capital shortfall that results from a financial crisis by estimating a macro-finance dynamic stochastic general equilibrium model that captures the interactions between the financial and real sectors of the euro-area economy. The introduction of both deposit and shadow banks captures several characteristics of the banking system and reveals a financial amplification mechanism. By using a combination of a large positive risk shock and a large negative investment shock, we show that a crisis similar to that observed in 2008 would generate a bank capital shortfall between 2.2% and 3% of euro-area GDP, which corresponds to approximately 207–282 billion euros.

Loaded for bear: Bitcoin private wallets, exchange reserves and prices

This study highlights a special feature of cryptocurrency trading and offers information about investor behavior that cannot be observed in traditional financial markets. We find that investors prefer holding bitcoin off exchanges in private wallets and primarily use exchanges to trade. Consequently, bitcoin exchange reserve changes resulting from the movement of bitcoin between private wallets and exchange accounts are negatively related to contemporaneous and future bitcoin returns. Specifically, the transfer of bitcoin on exchanges implies increased selling pressure and the transfer off exchanges implies decreased selling pressure. In turn, flows onto exchanges are triggered by large negative shocks and increased volatility.

Business cycle asymmetries and the labor market

This paper shows that a search and matching model with idiosyncratic training cost shocks can explain the asymmetric movement of the job-finding rate over the business cycle and the decline of matching efficiency in recessions. Large negative aggregate shocks move the hiring cutoff into a part of the training cost distribution with higher density. The position of the hiring cutoff in the distribution is disciplined by the empirical elasticity of the job-finding rate with respect to market tightness. Our model explains a large fraction of the matching efficiency decline during the Great Recession and generates state-dependent effects of policy interventions.

The effects of a negative economic shock on male marriage in the West Bank

This study examines how a large negative economic shock impacts marriage rates for young men in the West Bank. Utilizing data from before and after the sudden and abrupt closure of the Israeli labor market for Palestinian commuters from the West Bank in 2001, our empirical design employs a difference-in-difference strategy and uses the variations in localities’ exposure to the Israeli labor market before the shock. The closure reduced the employment and income of adult men asymmetrically across localities. Our findings show that the closure caused a reduction in marriage rates among young men aged 19 to 29 years, as post-shock changes in marriage rates. Our results suggest that the adverse effect of the economic shock on male marriage is mediated through a combination of rising youth unemployment and rigid expectations about marriage costs.

Network Analysis of SIFIs Based on Tail Systemic Linkage

This article applies several distinct methods including the systemic linkage method and network analysis to address intranational systemic risk interdependencies. Specifically, we initially quantify dynamic systemic linkages among US and Chinese systemically important financial institutions through time-varying adjacency matrices related to an extreme value theory (EVT) approach and then visualize them using network analysis. Numerical and graphical results show that intranational systemic linkages are obviously enhancive under extreme scenarios such as large negative shocks in the financial system. In addition, we apply a tail event-driven network quantile regression (TENQR) model to address the interdependence and dynamics of the entire network. The estimation results show that the network factors respond more strongly when the market suffers extreme stress.

Optimal Monetary Policy under Balance-Sheet Effects on the Non-tradable Sector in a Small Open Economy

The choice of an exchange rate regime is crucial in small open economies (SOEs) with a dollarized financial sector. While the traditional Mundell–Fleming model supports a floating exchange rate, evidence shows that central banks frequently intervene in exchange markets. One of the reasons for these interventions is the consequences of large depreciations that could trigger negative balance-sheet effects. This paper extends the literature about the optimal monetary policy in SOEs, by considering a heterogeneous hedge across tradable and non-tradable sectors. Our findings support a ‘leaning against the wind’ policy as an optimal response to negative external shocks. This result is present even if only one sector of the economy faces credit constraints. We show that the vulnerability of the economy to large negative external shocks depends not only on the overall leverage, but also on the distribution of foreign currency debt across economic sectors.

Educational choices and labour market outcomes in times of crisis

In this article, we estimate the impact of a large negative trade shock on labour market outcomes and educational choices of workers. We exploit the Canadian lumber export crisis beginning in 2007 in a quasi-experimental design. The crisis was sudden and more pronounced in the forestry industry than in comparable industries. We find that the employment probability of forestry industry workers decreased by 3.8 percentage points following the crisis relative to other workers in comparable industries. While one would expect younger forestry workers to return to school in such circumstances, we find that in the first two years following the crisis, unemployed workers did not go back to school. However, going back to school takes time, and after 3 to 4 years, we find that education enrolment increases by 2.9 percentage points, with a stronger effect on younger individuals (7.8 p.p.). This suggests that increases in education enrolment are gradual, as it is easier to drop out than to enrol. Facilitating access to post-secondary institutions for workers who lost their job’s permanently would be a valuable policy intervention.

Large Oil Shocks and Economic Growth: Evidence from Saudi Arabia

This paper aims to analyze the impact of large oil shocks on economic growth in Saudi Arabia, using a standard VAR model and a Markov-switching heteroscedastic regime, by using a quarterly data from 1981Q1 to 2019Q4. The results indicated that there were three large negative oil shocks, 1986Q1, 2008Q4, and 2014Q4, but there was only one large positive shock in 1990Q3. The impulse response and variance decomposition analysis show that both large negative and positive oil shocks have positive impacts on economic growth in Saudi Arabia, although only large negative shocks are statistically significant. Furthermore, large oil shocks only have a significant positive impact on economic growth comparing with normal oil shocks.

The fiscal response to revenue shocks

We study the impact of fiscal revenue shocks on local fiscal policy. We focus on the very volatile revenues from the immovable property gains tax in the canton of Zurich, Switzerland, and analyze fiscal behavior following large and rare positive and negative transitory revenue shocks. We apply causal machine learning strategies and implement the post-double-selection LASSO method to identify the effect of revenue shocks on public finances. We find that local policymakers predominantly smooth transitory fiscal shocks.

Earnings dynamics of immigrants and natives in Sweden 1985–2016

This paper analyzes earnings inequality and earnings dynamics in Sweden over 1985–2016. The deep recession in the early 1990s marks a historic turning point with a massive increase in earnings inequality and earnings volatility, and the impact of the recession and the recovery from it lasted for decades. In the aftermath of the recession, we find steady growth in real earnings across the entire distribution for men and women and decreasing inequality over more than 20 years. Despite the positive trend, large gender differences in earnings dynamics persist. While earnings growth for men is more closely tied to the business cycle, women face much higher volatility overall. Earnings volatility is also substantially higher among foreign‐born workers, reflecting weaker labor market attachment and high risk of large negative shocks for low‐income immigrants. We document an important role of social benefits usage for the overall trends and for differences across subpopulations. Higher benefits enrollment, especially for women and immigrants, is associated with higher earnings volatility. As the generosity and usage of benefit programs declined over time, we find stronger earnings growth among low‐income workers, consistent with higher self‐sufficiency.

Temporary overpessimism: Job loss expectations following a large negative employment shock

AbstractJob loss expectations were widespread amongst workers in East Germany following reunification with West Germany. Though experiencing a large negative employment shock, East German workers were nevertheless overpessimistic immediately after reunification with respect to their job loss risk. Over time, job loss expectations fell and converged to West German levels, which was driven by a stabilizing economic environment and by an adaptation of the interpretation of economic signals with workers learning to distinguish individual risk from firm‐level risk. In fact, conditional on actual job loss risk, East German workers quickly caught up to West Germans regarding the share of correctly predicted job losses.

Addressing Spillovers from Prolonged U.S. Monetary Policy Easing

There is growing recognition that prolonged monetary policy easing of major economies can have extraterritorial spillovers, driving up financial system leverage in other countries. When faced with such a rise of threats to financial stability, what can countries do? Specifically, is there a role for macroprudential tools, capital controls or foreign exchange intervention in safeguarding financial stability from risks arising externally? We examine the efficacy of these policy interventions by exploring whether preemptive or reactive policy interventions can mitigate such risks. Using a sample of 950 bank and nonbank financial firms across 28 non-U.S. economies over the past two decades, we show that if policymakers are able to implement policies prior to an additional consecutive decline in U.S. interest rates, financial institutions do not increase their leverage by as much as they otherwise would. By contrast, it is more difficult to counter the spillovers with reactive policy interventions. In practice, however, policymakers need to remain cautious about the timing of preventative tightening, especially when their economies face large negative shocks such as a pandemic.

Arbitrage Capital of Global Banks

We show that the role of unsecured, short-term wholesale funding for global banks has changed significantly in the post-financial-crisis regulatory environment. Global banks mainly use such funding to finance liquid, near risk-free arbitrage positions—in particular, the interest on excess reserves arbitrage and the covered interest rate parity arbitrage. In this environment, we examine the response of global banks to a large negative wholesale funding shock as a result of the U.S. money market mutual fund reform implemented in 2016. In contrast to past episodes of wholesale funding dry-ups, we find that the primary response of global banks to the reform was a cutback in arbitrage positions that relied on unsecured funding, rather than a reduction in loan provision.