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Extreme Linkages in Financial Markets: Macro Shocks and Systemic Risk

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  • Charnchai Leuwattanachotinan
  • Casper G. de Vries

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.

Suggested Citation

  • Charnchai Leuwattanachotinan & Casper G. de Vries, 2015. "Extreme Linkages in Financial Markets: Macro Shocks and Systemic Risk," PIER Discussion Papers 2, Puey Ungphakorn Institute for Economic Research.
    • Handle: RePEc:pui:dpaper:2
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    References listed on IDEAS

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    More about this item

    Keywords

    Spillover; Systemic risk; Macro shock; Extreme Value Theory;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • F3 - International Economics - - International Finance
    • C49 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Other
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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