Vulnerable Funding in the Global Economy

Abstract

We study the international propagation of financial conditions from the United States to global financial markets. The impact is highly heterogeneous alongside the quantiles of the distribution of the two major funding sources, credit and equity. Indeed, it is greater on the lower quantiles, which means that analogous to vulnerable growth episodes, examined by the past literature, there exist as well vulnerable funding periods of a global scale, originated from financial weakness in the US. These episodes are related to downside risk in terms of credit creation and firms’ market value around the world. Our estimates differentiate between first and second moment (i.e. uncertainty) shocks to financial conditions. This distinction proves to be relevant as it uncovers a complex propagation of shocks via different economic channels. On the one hand, credit growth largely responds to first moment shocks of US financial conditions four quarters after their occurrence, which is consistent with a credit view explanation of the transmission. On the other hand, stock markets react more sensitively and rapidly (mainly within a quarter) to second moment shocks, which can be theoretically associated with a portfolio channel underlying the shocks spread. We also document a heterogeneous impact across countries. In the case of credit growth this heterogeneity is better explained by the size or depth of the markets, while in the case of stock markets, the explanation is rooted on the strength of the financial connectedness with the US.