Journal Article

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

Choi, Sangyup

2018

Overview

I document that US financial 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 financial uncertainty shocks to EMEs. I augment a boom-bust cycle model of EMEs by Schneider and Tornell (Rev Econ Stud 71(3):883–913 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 financial 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.

• Publisher: Springer Nature B.V
• Subject: Borrowing / Credit / Decision making models / Depreciation / Economic models / Emerging markets / Investors / Market economies / Money / Portfolios / Regularity / Stock market indexes / Uncertainty