Posts this month
A blog on financial markets and their regulation
Historically, the VIX (the volatility of the US stock market implied by option prices) has been an important barometer of global risk aversion that has a strong influence on global capital flows. A BIS Working Paper published last month (Avdjiev, Gambacorta, Goldberg and Schiaffi, “The Shifting Drivers of Global Liquidity”) demonstrate that this changed in the aftermath of the Global Financial Crisis with US monetary policy becoming the dominant driver of capital flows while the VIX declined in importance. They also point out that this phenomenon peaked in 2013 and there has been a partial return to pre-crisis patterns since then.
The results make intuitive sense: as global central banks pursued unconventional monetary policy, a large amount of duration risk ended up on the ever expanding balance sheets of these central banks. They thus became the marginal risk taker in the economy. (The authors use the Wu-Xia shadow rate as their measure of US monetary policy to take account of the impact of unconventional monetary policy). Since 2013, the central banks have been in tapering mode and they are no longer the marginal risk taker in the economy.
Though the authors do not venture down this path, I think their results explain well why the 2013 taper talk had such a drastic impact on emerging markets while the coordinated tightening by global central banks during the last year has had such a muted impact. The marginal risk taker is now the private investor and the low level of VIX currently indicates that the marginal risk taker is in “risk on” mode. This suggests that we should be looking at the VIX rather than at global monetary policy for the early warning signs of the next wave of turbulence in emerging markets.