| Abstract: |
I develop a measure of changing tail risk perceptions based on global
financial shocks reflecting 'flights-to-safety'. Large flight-to-safety shocks
are defined as joint tail realizations of returns across major risky and safe
asset classes. Flight-to-safety shocks are substantially distinct from VIX
innovations, map to unexpected global events, inform future changes in world
prices and interest rates, and reflect both risk sentiment and global demand.
Estimating a multi-country structural VAR with country-specific heterogeneity,
I show that global flight-to-safety shocks induce a sharp rise in sovereign
risk and exchange market pressure, followed by a subsequent drop in economic
activity in both emerging markets and the U.S. However, the macroeconomic
effects of flight-to-safety shocks are far from uniform across emerging
markets, with domestic financial factors moderating the transmission
mechanism. Countries realizing larger sovereign risk adjustment or sharper
currency depreciation from a flight-to-safety shock are subject to deeper
subsequent economic contractions. The impact of flight-to-safety shocks on
economic activity is four times larger for emerging markets with substantial
presence in U.S. exchange traded funds. By contrast, leaning against the wind
by aggressively expending international reserves limits the economic impact of
global flight-to-safety shocks, with its effectiveness rising when the
exchange rate is successfully stabilized. |
| Keywords: |
Tail Risk, Risk-off, Risk Sentiment, Global Shocks, Contagion, International Spillovers, Sovereign Risk, Monetary Policy, Capital Flows, Emerging Markets |