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Global Flight-to-Safety Shocks

Ahmed, Rashad (2020): Global Flight-to-Safety Shocks.

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Abstract

I develop a measure of global financial shocks based on observed 'flights-to-safety', where large shocks are defined as joint tail realizations of returns across major risky and safe assets. Flights-to-safety map to unexpected tail events, inform future changes in world prices and interest rates, and shape business cycle dynamics. Estimating a multi-country structural VAR with country-specific heterogeneity, I show that across emerging markets, a global flight-to-safety shock induces a sharp rise in sovereign risk and exchange market pressure followed by a protracted drop in economic activity. Moreover, these effects vary systematically across countries in ways which support a risk-centric view of aggregate dynamics. The impact of flights-to-safety on economic activity is amplified in countries realizing sharper adjustment in risk premia and is four times larger in emerging markets with U.S. exchange traded funds. Meanwhile, leaning against the wind by expending international reserves acts as a policy-put, mitigating the impact of global flights-to-safety.

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