The Impact of US Financial Uncertainty Shocks on Emerging Market Economies: An International Credit Channel

I document that US nancial uncertainty shocks, measured by an increase in VIX, have a substantial impact on the output of emerging market economies (EMEs) without a material impact on US output during the last two decades. To understand this puzzling phenomenon, I propose a credit channel as a propagation mechanism of US nancial uncertainty shocks to EMEs. I augment a boom-bust cycle model of EMEs by Schneider and Tornell [2004] with a portfolio choice model of constrained international investors. As international investors pull their money from EMEs|to satisfy their Value-at-Risk constraints|in response to nancial uncertainty shocks, borrowing costs increase and domestic credit contracts. Higher borrowing costs and a decline in domestic credit, in turn, lead to a fall in investment in the non-tradable sector that causes a real depreciation via currency mismatch prevalent in EMEs and a decline in total output through sectoral linkages. The empirical regularity obtained by estimating structural VARs of 18 EMEs is consistent with the prediction of the model.