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Liquidity, risk and the global transmission of the 2007-08 financial crisis and the 2010-2011 sovereign debt crisis

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Listed author(s):
  • Fratzscher, Marcel
  • Chudik, Alexander

Abstract

The paper analyses the transmission of liquidity shocks and risk shocks to global financial markets. Using a Global VAR methodology, the findings reveal fundamental differences in the transmission strength and pattern between the 2007-08 financial crisis and the 2010-11 sovereign debt crisis. Unlike in the former crisis, emerging market economies have become much more resilient to adverse shocks in 2010-11. Moreover, a flight-to-safety phenomenon across asset classes has become particularly strong during the 2010-11 sovereign debt crisis, with risk shocks driving down bond yields in key advanced economies. The paper relates this evolving transmission pattern to portfolio choice decisions by investors and finds that countries' sovereign rating, quality of institutions and their financial exposure are determinants of cross-country differences in the transmission. JEL Classification: E44, F3, C5

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Paper provided by European Central Bank in its series Working Paper Series with number 1416.

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Date of creation: Feb 2012
Handle: RePEc:ecb:ecbwps:20121416
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Keywords: advanced economies; capital flows; emerging market economies; global financial crisis; high dimensional VARs; liquidity; risk; sovereign debt crisis; transmission;

Find related papers by JEL classification:

  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • F3 - International Economics - - International Finance
  • C5 - Mathematical and Quantitative Methods - - Econometric Modeling

This paper has been announced in the following NEP Reports:

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  1. Jean Tirole, 2011. "Illiquidity and All Its Friends," Journal of Economic Literature, American Economic Association, vol. 49(2), pages 287-325, June.
  2. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
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  5. Filippo di Mauro & L. Vanessa Smith & Stephane Dees & M. Hashem Pesaran, 2007. "Exploring the international linkages of the euro area: a global VAR analysis," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 1-38.
  6. Chudik, Alexander & Fratzscher, Marcel, 2010. "Identifying the Global Transmission of the 2007-09 Financial Crisis in a GVAR Model," CEPR Discussion Papers 8093, C.E.P.R. Discussion Papers.
  7. Michael Ehrmann & Marcel Fratzscher & Roberto Rigobon, 2011. "Stocks, bonds, money markets and exchange rates: measuring international financial transmission," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 26(6), pages 948-974, 09.
  8. Hui Tong & Shang-Jin Wei, 2008. "Real Effects of the Subprime Mortgage Crisis; Is it a Demand or a Finance Shock?," IMF Working Papers 08/186, International Monetary Fund.
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  11. M. Hashem Pesaran & L. Vanessa Smith & Ron P. Smith, 2007. "What if the UK or Sweden had joined the euro in 1999? An empirical evaluation using a Global VAR," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(1), pages 55-87.
  12. M. Hashem Pesaran & Til Schuermann & Bjorn-Jakob Treutler, 2007. "Global Business Cycles and Credit Risk," NBER Chapters,in: The Risks of Financial Institutions, pages 419-474 National Bureau of Economic Research, Inc.
  13. Bekaert, Geert & Ehrmann, Michael & Fratzscher, Marcel & Mehl, Arnaud, 2011. "Global crises and equity market contagion," CEPR Discussion Papers 8438, C.E.P.R. Discussion Papers.
  14. Michael Ehrmann & Marcel Fratzscher, 2005. "Equal Size, Equal Role? Interest Rate Interdependence Between the Euro Area and the United States," Economic Journal, Royal Economic Society, vol. 115(506), pages 928-948, October.
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  16. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
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  19. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 418-437, July.
  20. Bussière, Matthieu & Chudik, Alexander & Mehl, Arnaud, 2011. "Does the euro make a difference? Spatio-temporal transmission of global shocks to real effective exchange rates in an infinite VAR," Working Paper Series 1292, European Central Bank.
  21. Xavier Sala-I-Martin & Gernot Doppelhofer & Ronald I. Miller, 2004. "Determinants of Long-Term Growth: A Bayesian Averaging of Classical Estimates (BACE) Approach," American Economic Review, American Economic Association, vol. 94(4), pages 813-835, September.
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  23. John B. Taylor, 2009. "The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong," NBER Working Papers 14631, National Bureau of Economic Research, Inc.
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Cited by:

  1. Georgiadis, Georgios, 2016. "Determinants of global spillovers from US monetary policy," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 41-61.
  2. Benhabib, Jess & Liu, Xuewen & Wang, Pengfei, 2016. "Sentiments, financial markets, and macroeconomic fluctuations," Journal of Financial Economics, Elsevier, vol. 120(2), pages 420-443.
  3. Chen, Qianying & Filardo, Andrew & He, Dong & Zhu, Feng, 2016. "Financial crisis, US unconventional monetary policy and international spillovers," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 62-81.

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