China’s footprint in global financial markets
Lodge, David; Manu, Ana-Simona; Van Robays, Ine (15.02.2024)
Numero
1/2024Julkaisija
Bank of Finland
2024
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe202402157429Tiivistelmä
Using daily data since 2017, we disentangle China-specific structural shocks driving Chinese financial markets and examine spillovers across global markets. The novelty of this paper consists of simultaneously identifying China shocks with shocks emanating from the United States and shocks to global risk sentiment – two major forces driving global financial markets – to ensure that China spillover estimates do not reflect common factors. Our results show that shocks originating in China have material impacts on global equity markets, although spillovers are much smaller than those following shocks in the United States, or those triggered by shifts in global risk sentiment. By contrast, shocks from China account for a significant proportion of variation in global commodity prices, more on a par with those of the United States. Nevertheless, spillovers from China can be significantly amplified in an environment of heightened global volatility, or when the shocks are large.
Julkaisuhuomautus
NON-TECHNICAL SUMMARY
FOCUS
What happens to global financial markets when China catches a cold? This paper investigates how shocks in China’s financial markets ripple through global financial markets. This is not an easy task; global financial markets are driven by a multitude of shocks which interact at high frequency.
CONTRIBUTION
We propose an empirical framework that jointly decomposes daily movements in Chinese and US financial asset prices into underlying drivers in the spirit of Brandt et al. (2021), thereby aiming to better control for possible commonalities. After years of financial liberalisation, China’s financial markets appear sufficiently reflective of economic conditions to extract information from their co-movement to identify the underlying shocks driving assets price correlations. Once identified, we use the shocks to map out the spillovers from China to financial markets in the rest of the world and to commodities using local projections.
FINDINGS
We find that shocks emanating from China leave a footprint on global financial markets, but the impact is smaller than those of US or global risk shocks. Global equity prices respond significantly to Chinese macro risk shocks but the impact of shocks stemming from the US or global risk shocks can be up to three times as large. That supports the finding of the previous literature that shocks in the US, and in global risk sentiment, are key factors shaping global financial markets (Rey, 2015; Georgiadis et al., 2021b). Yet we also find that shocks originating in China play a significantly more important role in global commodity markets, in some cases even more important than shocks originating in the US. That is consistent with the role played by China in the demand for global energy and non-energy commodities. Finally, we show that spillovers of China shocks are reinforced when shocks hit in a time of heightened global volatility or when the shocks are large in size.
FOCUS
What happens to global financial markets when China catches a cold? This paper investigates how shocks in China’s financial markets ripple through global financial markets. This is not an easy task; global financial markets are driven by a multitude of shocks which interact at high frequency.
CONTRIBUTION
We propose an empirical framework that jointly decomposes daily movements in Chinese and US financial asset prices into underlying drivers in the spirit of Brandt et al. (2021), thereby aiming to better control for possible commonalities. After years of financial liberalisation, China’s financial markets appear sufficiently reflective of economic conditions to extract information from their co-movement to identify the underlying shocks driving assets price correlations. Once identified, we use the shocks to map out the spillovers from China to financial markets in the rest of the world and to commodities using local projections.
FINDINGS
We find that shocks emanating from China leave a footprint on global financial markets, but the impact is smaller than those of US or global risk shocks. Global equity prices respond significantly to Chinese macro risk shocks but the impact of shocks stemming from the US or global risk shocks can be up to three times as large. That supports the finding of the previous literature that shocks in the US, and in global risk sentiment, are key factors shaping global financial markets (Rey, 2015; Georgiadis et al., 2021b). Yet we also find that shocks originating in China play a significantly more important role in global commodity markets, in some cases even more important than shocks originating in the US. That is consistent with the role played by China in the demand for global energy and non-energy commodities. Finally, we show that spillovers of China shocks are reinforced when shocks hit in a time of heightened global volatility or when the shocks are large in size.