Karlye Dilts-Stedman | Macro Paper Warehouse

Capital Flows in Risky Times: Risk-on/Risk-off and Emerging Market Tail Risk

Research on cross-border capital flows has concentrated on the first moment – what moves average flows and average returns. This paper asks instead how shifts in global risk appetite reshape the whole distribution of emerging-market portfolio flows and asset returns, and in particular the left tail. It measures “risk-on/risk-off” (RORO) two ways: a statistical index built as the first principal component of daily changes across advanced-economy credit spreads, equity returns and implied volatility, funding-liquidity spreads, and the dollar and gold; and, to separate the price of risk from the quantity of risk, the model-based risk aversion series of Bekaert, Engstrom and Xu (2020). Both measures are right-skewed and fat-tailed, spiking in the global financial crisis, the European debt crisis, the taper tantrum and COVID-19. Outcomes are weekly EPFR country flows (scaled by the previous week’s allocation) and daily total returns from the EMBI, a local-currency bond index, and MSCI local-currency and dollar equity indices, for 22 emerging markets, beginning 7 January 2004 and running to April 2020, with push and pull controls and country and time fixed effects. Estimating panel quantile regressions in the manner of Machado and Santos Silva (2019), the paper finds that a risk-off shock lowers flows and returns across the distribution, and that “in nearly every case we consider” the fifth-percentile realisation moves more than the median while the ninety-fifth moves less – so the distribution shifts left and lengthens. The exceptions and the asymmetries are the interesting part. Bond-fund flows shift left with tails pulled apart; equity-fund flows shift left with tails modestly pulled in, a pattern the paper traces specifically to sensitivity to risk aversion rather than to physical risk. Among returns, equity is far more sensitive than fixed income – more than fivefold on the statistical measure – and within each asset class dollar-denominated indices react more than local-currency ones. Decomposing the index, corporate spreads supply much of the leftward shift and funding liquidity much of the bond funds’ tail-lengthening; the risk-aversion component dominated the global financial crisis while the quantity of risk dominated COVID-19. The paper’s conclusion is methodological as much as substantive: a focus on central tendency is “incomplete,” because the tail responses it documents would be masked by conditional means and variances.

Spillovers at the extremes: The macroprudential stance and vulnerability to the global financial cycle

The existing evidence says macroprudential regulation does little to portfolio capital flows; this paper argues that finding is an artefact of looking only at averages. It links two literatures – one on the leakages and spillovers from macroprudential policy, one on extreme events in capital flows – and asks whether a country’s ex-ante macroprudential stance changes how sensitive its bond and equity portfolio flows are to the global financial cycle. The answer is yes, in the tails and not at the mean. Tighter prior regulation amplifies risk shocks in both directions: bigger inflows during risk-on episodes, bigger outflows during risk-off ones. Four innovations make the result visible. Rather than dummy variables for recent policy changes, the paper builds four measures of the regulatory stance that incorporate intensity, combining Bank for International Settlements and European Systemic Risk Board data on countercyclical capital buffer levels with the IMF’s iMaPP database, including its quantitative loan-to-value ratios. Risk is measured by the RORO index of Chari, Dilts-Stedman and Lundblad (2020), the first principal component of daily changes in advanced-economy credit spreads, equity returns and volatilities, funding-liquidity spreads, the dollar and gold, whose distribution is skewed toward risk-off. Flows come from weekly EPFR data covering over 14,000 equity funds and 7,000 bond funds with more than $8 trillion under management, cleansed of valuation effects. And reverse causality – policymakers tightening because flows surged – is handled with a policy-shocks approach that regresses the stance on eighteen crisis, credit, growth and institutional variables and uses the residual, with first-stage F-statistics around 100. On a sample of 65 countries excluding the United States, Japan and Switzerland, the second stage reproduces the two known facts: a one-unit rise in RORO cuts weekly bond flows by 0.09 to 0.10 percent, about $2.3 to $2.4 billion, while the macroprudential stance on its own is insignificant. The interaction is where the new result sits: negative and usually significant, but modest at the mean, worth only $151 to $543 million of extra bond outflow. Evaluated across the risk distribution it grows sharply – for the preferred Broad Intensity Index, a one-unit tighter stance adds nothing at median risk but -$636 million, -$1,529 million and -$2,076 million at the 95th, 99th and 99.5th percentiles, against an unconditional risk effect of about -$2 billion, and +$631 million to +$1,215 million at the 5th to 0.5th percentiles. At a 99th-percentile shock (a RORO of 3.49, reached in 2008-09, 2011 and 2020), the amplification of bond outflows is 22 to 87 percent across all four measures and 45 to 67 percent for the two preferred ones. The pattern holds for equities with smaller coefficients but larger dollar amounts, and it is driven by tools that target specific exposures – LTV ratios, FX measures, bank credit supply – while the countercyclical capital buffer and demand-side measures show the same sign but no significance. The authors are explicit about the inference they are not making: “we do not suggest that macroprudential policies render the broader economy less resilient or more sensitive to risk shocks – as the increased resilience of banks may outweigh the greater sensitivity of non-bank financial intermediation.”

Taper Tantrums: Quantitative Easing, Its Aftermath, and Emerging Market Capital Flows

Identifying US monetary policy shocks from daily moves in five-year Treasury futures around FOMC announcements, this paper shows that during the unconventional-policy years those shocks largely represent revisions to required risk compensation rather than to the expected short-rate path, and that their effects on emerging market portfolio positions run mainly through valuations rather than physical flows – with by far the largest effects during the taper period. The shock measure follows Rogers, Scotti and Wright (2014): the daily change in the implied yield of the five-year Treasury futures contract on FOMC announcement dates, plus the additional policy events in Gagnon et al. (2011) and the taper-tantrum date of 22 May 2013. Its average value is a fall of 2.0 basis points during the QE period and a rise of 1.6 basis points during the taper period, against minus 0.6 for the full sample and minus 0.5 pre-crisis, with the period differences statistically significant. Feeding the shock through the Kim and Wright (2005) affine term structure decomposition shows it moves both the expected short rate and the term premium in the conventional period, but that in the unconventional periods the largest effects are on term premia and those effects rise monotonically with maturity – a one-standard-deviation shock raises the ten-year yield by 4.7 basis points pre-crisis but 12.2 basis points during QE, against unconditional daily ten-year standard deviations of 5.8 and 7.1 basis points respectively. The capital-flow analysis uses Bertaut-Tryon and Bertaut-Judson monthly estimates built from US Treasury International Capital data, covering 15 emerging markets monthly from 1994 to 2014, with positions, flows and valuation changes for debt and equity separately scaled by annual GDP, estimated in a random-effects panel with lagged dependent variables, an extensive set of lagged push and pull controls, and country-clustered robust standard errors. Three kinds of heterogeneity emerge. Flows versus prices: “in nearly every specification, the effect of monetary policy shocks on asset returns is larger than that for physical flows,” which the authors read as consistent with the shocks capturing revisions in required risk compensation. Debt versus equity: during QE the coefficient on equity valuations is ten times that on debt valuations, and during the taper period equity effects are double or triple debt effects. QE versus tapering: during QE the significant responses are confined to debt and equity valuations and equity positions, whereas after tapering was first mentioned the coefficients are inversely signed and significant at the 1 percent level across essentially every variable, and an order of magnitude larger than pre-crisis for debt positions, debt valuations and equity flows. Because the shock has a magnitude, the paper can price these effects: a mean-sized QE shock corresponds to roughly a $153.5 million monthly increase in US emerging market equity positions per country, a mean-sized taper shock to a $144.1 million monthly outflow, with one-standard-deviation ranges of roughly minus $672 million to plus $979 million during QE. The paper is explicit that its estimates are associations from a controlled panel regression rather than structural effects: coefficients are described throughout as correlations, the shock’s channel is inferred from coefficient signs rather than separately identified, and the exchange rate results, while statistically significant, are reported as economically modest against an unconditional monthly bilateral exchange rate standard deviation of 3.57 percent.

Unconventional monetary policy spillovers and the (in)convenience of Treasuries

Research Question

The paper asks why unconventional monetary policy (UMP) spillovers from the European Central Bank (ECB) to the U.S. Treasury yield curve vary so substantially over time, and whether the time-varying “convenience” of Treasuries — their non-pecuniary premium as the world’s preeminent safe asset — can explain that variation. The core claim is that a declining convenience yield on Treasuries makes them more substitutable with other safe sovereign bonds, thereby amplifying the portfolio-balance channel through which foreign large-scale asset purchases (LSAPs) depress U.S. term premia.