Extreme Linkages in Financial Markets: Macro Shocks and Systemic Risk

Charnchai Leuwattanachotinan and Casper de Vries

No 2, PIER Discussion Papers from Puey Ungphakorn Institute for Economic Research

Abstract: The recent IMF World Economic Outlook (2013) investigates how real and ï¬ nancial shocks can cause a sharp increase in cross country output co-movements. This paper looks at the reverse issue by asking how macro regimes of extreme low and high inflation or productivity growth are conducive to spillover of ï¬ nancial market shocks between major open economies. Using a non-parametric measure we study the largest movements in the US and German equity index returns conditional on a speciï¬ c macro regime in one or both of the countries. It is known that the unconditional probability of different stock markets crashing jointly is non-negligible, see e.g. Hartmann et al. (2004) and Poon et al. (2004). The results suggest that the factor related to real economy, i.e. industrial production growth, is a major driver behind the extreme loss linkage, but inflation is not. One explanation is that monetary policy shocks are absorbed by the exchange rate, whereas technology shocks do spillover.

Keywords: Spillover; Systemic risk; Macro shock; Extreme Value Theory (search for similar items in EconPapers)
JEL-codes: C49 E44 F3 G1 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2015-09
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