Uncertainty and Episodes of Extreme Capital Flows in the Euro Area

Schmidt, Torsten; Zwick, Lina

doi:10.2139/ssrn.2421260

Cited by 12 publications

(11 citation statements)

References 27 publications

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“…For example, Schmidt and Zwick (2015), using data for the Euro area, conclude that domestic volatility (i.e. uncertainty about the evolution of the economy and the economic policy being implemented) played an important role in determining the dynamics of gross capital flows and the increase in home bias observed in the Euro area during the crisis.…”

Section: Introductionmentioning

confidence: 99%

Domestic Antidotes to Sudden Stops

Cavallo¹,

Izquierdo²,

León-Díaz³

2017

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Inter-American Development Bank. This work is licensed under a Creative Commons IGO 3.0 AttributionNonCommercial-NoDerivatives (CC-IGO BY-NC-ND 3.0 IGO) license (http://creativecommons.org/licenses/by-nc-nd/3.0/igo/ legalcode) and may be reproduced with attribution to the IDB and for any non-commercial purpose. No derivative work is allowed.Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC-IGO license.Note that link provided above includes additional terms and conditions of the license.The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.http://www.iadb.org 2017 AbstractSudden Stops in net capital flows can be prevented when the actions of domestic investors offset a reduction in foreign lending. This paper presents evidence that while sudden stops in gross inflows-i.e., a tightening of the external borrowing constraint-are associated with global conditions and therefore, are largely outside of the control of local policymakers, domestic factors such as low levels of liability dollarization, exchange rate flexibility, inflation targeting regimes, and a solid institutional background are important to prevent these episodes from becoming sudden stops in net capital flows. Under these favorable local conditions, domestic investors may perceive reduced risk in bringing in resources at the time of an external shock, thus insulating the country from this shock. JEL classifications: E44, E58, E60

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Section: Introductionmentioning

confidence: 99%

Domestic Antidotes to Sudden Stops

Cavallo¹,

Izquierdo²,

León-Díaz³

2017

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“…We want to establish a general transmis-sion mechanism between our variables of interest that would be relevant for the entire sample once individual heterogeneity is controlled for and that would allow for obtaining non-country-specific Figure 4 shows that a debt to GDP ratio shock triggers a positive significant response in home bias. Similarly, Schmidt and Zwick (2015) and Brutti and Sauré (2015) show that country-specific risk factors are crucial in explaining extreme capital flows in the Euro area. As this result is significant at the panel level, it suggests that debt shocks impact positively home bias both in countries where its recent increase was driven by a decrease in foreign volume and an increase in domestic volume and in countries where it was driven by domestic volume increasing faster than foreign volume, what is also confirmed by invididual tests presented below.…”

Section: Interpretation Of Resultsmentioning

confidence: 91%

Increase in home bias in the Eurozone debt crisis: The role of domestic shocks

2016

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Abstract:One of the most striking consequences of the recent episode of sovereign debt market stress in the Eurozone has been the increase in the share of public debt held by the domestic sector in fragile economies. However, the causes and potential consequences of this increase were only given scarce attention in the literature on the Euro area sovereign debt crisis. In order to fill this gap, we first identify the shocks that impact the variation in the share of sovereign debt held at home in an SVAR model on a sample of Eurozone countries between 2002 and 2014, distinguishing between external and domestic shocks. Thanks to several alternative tests, we show that home bias in sovereign debt responds positively to country-specific fundamentals and expectations shocks but we find no evidence that the increase in home bias is destabilizing per se in the short-run. Second, a stylized theoretical model backed by the empirical results predicts that the consequences for sovereign debt crisis depend on the relative impact of domestic initial destabilizing shocks and increased home bias. The analysis suggests that an increase in home bias in times of sovereign debt stress, despite reflecting deteriorating fiscal conditions, may make default less likely. Keywords:Eurozone, Sovereign debt crisis, Home bias, Bayesian panel SVAR JEL codes:Increase in home bias in the Eurozone debt crisis: the role of domestic shocks *Abstract: One of the most striking consequences of the recent episode of sovereign debt market stress in the Eurozone has been the increase in the share of public debt held by the domestic sector in fragile economies. However, the causes and potential consequences of this increase were only given scarce attention in the literature on the Euro area sovereign debt crisis. In order to fill this gap, we first identify the shocks that impact the variation in the share of sovereign debt held at home in an SVAR model on a sample of Eurozone countries between 2002 and 2014, distinguishing between external and domestic shocks. Thanks to several alternative tests, we show that home bias in sovereign debt responds positively to country-specific fundamentals and expectations shocks but we find no evidence that the increase in home bias is destabilizing per se in the short-run. Second, a stylized theoretical model backed by the empirical results predicts that the consequences for sovereign debt crisis depend on the relative impact of domestic initial destabilizing shocks and increased home bias. The analysis suggests that an increase in home bias in times of sovereign debt stress, despite reflecting deteriorating fiscal conditions, may make default less likely. JEL classification: E4, E5, F3, G15.Keywords: Eurozone, Sovereign debt crisis, Home bias, Bayesian panel SVAR. * We thank Stephan Sauer, Andrea Bonilla Bolaños, Aurélien Eyquem, Nicolas Houy, Bruno Ziliotto, as well as participants at the 11th Infiniti Conference, the 11th Macrofi workshop, the 2nd Finandebt Conference, the 63rd AFSE Conference and the 2nd Lyon-Tur...

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“…For example, Schmidt and Zwick (2015), using data for the Euro area, conclude that domestic volatility (i.e., uncertainty about the evolution of the economy and the economic policy being implemented) played an important role in determining the dynamics of gross capital flows and the increase in home bias observed in the Euro area during the crisis. Ghosh et al (2014) in turn, postulate that global factors, such as U.S. interest rates and global risk, are important elements associated with capital flows surges in emerging markets.…”

Section: Introductionmentioning

confidence: 99%

Domestic Antidotes to Sudden Stops

Cavallo¹,

Izquierdo²,

León-Díaz³

2017

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work is licensed under a Creative Commons IGO 3.0 AttributionNonCommercial-NoDerivatives (CC-IGO BY-NC-ND 3.0 IGO) license (http://creativecommons.org/licenses/by-nc-nd/3.0/igo/ legalcode) and may be reproduced with attribution to the IDB and for any non-commercial purpose, as provided below. No derivative work is allowed.Any dispute related to the use of the works of the IDB that cannot be settled amicably shall be submitted to arbitration pursuant to the UNCITRAL rules. The use of the IDB's name for any purpose other than for attribution, and the use of IDB's logo shall be subject to a separate written license agreement between the IDB and the user and is not authorized as part of this CC-IGO license.Following a peer review process, and with previous written consent by the Inter-American Development Bank (IDB), a revised version of this work may also be reproduced in any academic journal, including those indexed by the American Economic Association's EconLit, provided that the IDB is credited and that the author(s) receive no income from the publication. Therefore, the restriction to receive income from such publication shall only extend to the publication's author(s). With regard to such restriction, in case of any inconsistency between the Creative Commons IGO 3.0 Attribution-NonCommercial-NoDerivatives license and these statements, the latter shall prevail.Note that link provided above includes additional terms and conditions of the license.The opinions expressed in this publication are those of the authors and do not necessarily reflect the views of the Inter-American Development Bank, its Board of Directors, or the countries they represent.http://www.iadb.org 2017 Abstract * Sudden Stops in net capital flows can be prevented when the actions of domestic investors offset a reduction in foreign lending. This paper presents evidence that while sudden stops in gross inflows-i.e., a tightening of the external borrowing constraint-are associated with global conditions and therefore, are largely outside of the control of local policymakers, domestic factors such as low levels of liability dollarization, exchange rate flexibility, inflation targeting regimes, and a solid institutional background are important to prevent these episodes from becoming sudden stops in net capital flows. Under these favorable local conditions, domestic investors may perceive reduced risk in bringing in resources at the time of an external shock, thus insulating the country from this shock. JEL classifications: F30, F32, F40

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Uncertainty and Episodes of Extreme Capital Flows in the Euro Area

Cited by 12 publications

References 27 publications

Domestic Antidotes to Sudden Stops

Domestic Antidotes to Sudden Stops

Increase in home bias in the Eurozone debt crisis: The role of domestic shocks

Domestic Antidotes to Sudden Stops

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