Yves Nosbusch 




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Volatility originating in emerging markets

Global markets have experienced several bouts of high volatility since 2015, triggered by unforeseen developments in emerging markets, particularly in China. Moreover, a recent study by the International Monetary Fund in its April 2016 Global Financial Stability Report found that the share of volatility in advanced equity and currency markets attributable to spillovers from emerging countries is high (over 30%) and has been growing steadily since the mid-1990s. A priori there are several possible reasons why the transmission of shocks from emerging to advanced economies has become significantly stronger over the last two decades.


A first potential explanation is that the “portfolio channel” of contagion has intensified. The idea is that the significant increase in investments in emerging economies has created more market interconnections through portfolio managers. Gains and losses in one market can thus lead to purchases and sales in other markets. However, this channel does not seem to be the main reason for increased spillovers. Indeed, far more capital has flowed into bonds than into equities, suggesting that bond markets ought to have experienced a sharper increase in spillover effects than equity markets. Yet the data appear to indicate that the opposite is true.


Another possible explanation involves alternating “risk on/risk off” phases in markets. These movements could theoretically lead to correlated price changes across risky asset classes, particularly in the equity markets of advanced and emerging economies. Once again, this is unlikely to be the primary explanation for higher spillovers: the econometric model used by the authors of the IMF report to identify spillovers includes global control variables such as the implied volatility of the US equity market (measured by the VIX index), which is a proxy for global risk appetite.


This leaves one plausible channel, namely the “signalling channel”. The idea is that bad news from emerging markets heralds a decline in exports and, consequently, a dimmer growth outlook for advanced economies. Put differently, spillovers are chiefly due to macroeconomic fundamentals rather than technical factors such as portfolio flows or changes in investors' risk appetite. The increase in spillovers is thus attributable mainly to the growing share of emerging markets in global trade.



These findings are cause for concern at a time when a number of emerging economies are vulnerable due to a combination of factors, including low commodity prices, high levels of private sector debt and, in many cases, significant currency depreciation. Given that the global economy has become more closely integrated over the last twenty years, a negative shock in emerging countries would surely have a greater impact on the growth prospects of advanced countries than it did in the past.


Yves Nosbusch

Chief Economist

BGL BNP Paribas

Published on paperjam.lu (in French) on 2 June 2016