| Abstract: |
Using a new equity price-based measure of the global financial cycle, this
paper evaluates the relative importance of global financial shocks for
quarterly equity returns and output growths in a large sample of advanced and
emerging economies, as well as in South Korea and China--two countries on
different sides of the trilemma triangle of international finance. We document
that global financial shocks in both China and South Korea explain a
substantial share of equity return variability (20 and 50 percent of total
variance, respectively), but a much smaller portion of real output
fluctuations (less than 10 percent in Korea and negligible in the case of
China). We also find that the combination of a closer capital account and a
more rigid exchange rate regime, as in China, is associated with some costs in
terms of diversification opportunities quantified by very large exposures to
domestic financial and real shocks, dwarfing the contribution of any other
shock in the model. More surprisingly, the combination of a relatively open
capital account and a flexible exchange rate, as in South Korea, not only is
associated with a higher exposure to the global financial cycle than in China
but also with a significant incidence of domestic financial shocks on output
fluctuations. |