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«Lecturas de Economía ISSN: 0120-2596 lecturas Universidad de Antioquia Colombia Mosquera, Stephanía; Restrepo, Natalia; Uribe, Jorge ...»

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Lecturas de Economía

ISSN: 0120-2596

lecturas@udea.edu.co

Universidad de Antioquia

Colombia

Mosquera, Stephanía; Restrepo, Natalia; Uribe, Jorge

Effects of Stock Indices of Developed and Emerging Markets on Economic Activity in

Colombia: a FAVAR Approach

Lecturas de Economía, núm. 85, julio-diciembre, 2016, pp. 155-178

Universidad de Antioquia

Medellín, Colombia

Available in: http://www.redalyc.org/articulo.oa?id=155246479005

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Scientific Information System More information about this article Network of Scientific Journals from Latin America, the Caribbean, Spain and Portugal Journal's homepage in redalyc.org Non-profit academic project, developed under the open access initiative Effects of Stock Indices of Developed and Emerging Markets on Economic Activity in Colombia: a FAVAR Approach Stephanía Mosquera, Natalia Restrepo and Jorge Uribe Lecturas de Economía - No. 85. Medellín, julio-diciembre 2016 Lecturas de Economía, 85 (julio-diciembre 2016), pp. 155-178 Stephanía Mosquera, Natalia Restrepo and Jorge Uribe

Effects of Stock Indices of Developed and Emerging Markets on Economic Activity in Colombia:

a FAVAR Approach Abstract: We analyze the effect of global financial conditions of developed and emerging economies on economic activity in Colombia. To accomplish this task, we estimate financial conditions indices for the stock markets of developed and emerging countries using principal components analysis. Then, we include the estimated indices as regressors in a traditional vector autoregression (VAR) that includes series of economic activity in Colombia; that is, we carry out a factor-augmented vector autoregression (FAVAR) analysis with one unobservable factor and one observable variable accounting for real economic activity to evaluate the influence of international financial conditions on macroeconomic variables in Colombia. Using monthly data, we find that the stock market conditions of emerging economies have a positive effect on macroeconomic performance in Colombia.

Keywords: stock prices, financial conditions indices, factor-augmented vector autoregression, dynamic factor models JEL Classification: G10, G15, C38, E44 Efectos de los índices accionarios de los mercados desarrollados y emergentes sobre la actividad económica en Colombia: una aproximación FAVAR Resumen: Analizamos el efecto de las condiciones financieras de economías emergentes y desarrolladas sobre el comportamiento de la economía colombiana. Para ello, estimamos índices de condiciones financieras para mercados accionarios de países desarrollados y emergentes usando análisis de componentes principales. Posteriormente, estos índices se incluyeron como regresores en un modelo tradicional de vectores auto-regresivos (VAR); es decir, estimamos un modelo de vectores auto-regresivos aumentado con factores (FAVAR) que incluye un factor no observable y una variable observable de la actividad económica real con el fin de evaluar el efecto de las condiciones financieras internacionales sobre las variables macroeconómicas colombianas. De esta manera, encontramos que las condiciones accionarias de los países emergentes tienen un efecto positivo sobre el comportamiento macroeconómico de Colombia cuando se lleva a cabo el análisis con datos mensuales.

Palabras clave: precios de acciones, índices de condiciones financieras, vectores auto-regresivos aumentados con factores, modelos de factores dinámicos Clasificación JEL: G10, G15, C38, E44

Les effets des indices boursiers des pays développés et émergents sur l’économie colombienne:

Une approche FAVAR Résumé: Nous analysons l’effet des conditions financières des économies émergentes et développées sur la performance économique de Colombie. Pour ce faire, nous estimons des indices des conditions financières pour les marchés boursiers des pays développés ainsi que pour les émergents, tout en utilisant l’analyse en composantes principales. Ces indices sont ensuite considérés en tant que régresseurs dans un modèle traditionnel de vecteurs autorégressifs (VAR), c’est-à-dire que nous estimons un modèle vectoriel autorégressif augmenté par des facteurs (FAVAR), y compris un facteur non-observable et un facteur observable (l’activité économique réelle), afin d’évaluer l’effet des conditions financières internationales sur les variables macroéconomiques colombiennes. Lors de la réalisation de l’analyse avec des données mensuelles, nous constatons que les conditions boursières des pays émergents ont un effet positif sur la performance macroéconomique de Colombie.

Mots-clés: prix des actions, indices des conditions financières, modèle vectoriel autorégressif augmenté par des facteurs, modèles à facteurs dynamiques Classifcation JEL: G10, G15, C38, E44 Lecturas de Economía, 85 (julio-diciembre), pp. 155-178 © Universidad de Antioquia, 2016 Effects of Stock Indices of Developed and Emerging Markets on Economic Activity in Colombia: a FAVAR Approach Stephanía Mosquera, Natalia Restrepo and Jorge Uribe*

–  –  –

Financial markets have recently gained importance as one of the main factors behind the evolution of the real economy. Globalization and technological advances of information systems have enhanced the commercial and financial relationships among markets. Having more interconnected financial markets brings positive consequences for economies: agents have access to a higher number of financial assets, a wider range of portfolio diversification and risk management possibilities, and greater investment opportunities for national firms, among others. The relationship between different financial markets has also consequences on the real economy, as highlighted, for example, by Prasad, et al. (2004). Many of the ways in which financial and real * Stephanía Mosquera: Ph.D. Student, School of Industrial Engineering at the Universidad del Valle. Address: Calle 13 # 100-00, Edf. 357, Cali, Colombia. Contact information: stephania.mosquera.lopez@correounivalle.edu.co.





Natalia Restrepo: student of the Master in Applied Economics at the Universidad del Valle. Address: Calle 13 # 100-00, Edf. 357, Cali, Colombia. Contact information: natalia.x.restrepo@correounivalle.edu.co.

Jorge M. Uribe: Professor of Economics at the Universidad del Valle. Address: Calle 13 # 100-00, Edf. 387, Cali, Colombia. Contact information: jorge.uribe@coreounivale.edu.co.

Mosquera, Restrepo and Uribe: Effects of Stock Indices of Developed and Emerging...

markets interact remain as open questions; however, after the global financial crisis of 2007-2010, this interaction has become a first order interest in the academic agenda around the world.

Most studies regarding the effects of financial performance on the real economy have focused on studying the behavior of national financial markets, without considering the impact that international financial markets may have on national conditions. For example, Gómez, Murcia and Zamudio (2011) and Gerdrup and Hammersland (2006) recognize the relevance of national financial markets on the real economy. These authors also take into account the role of asset prices and financial indices as predictors of macroeconomic conditions. Other authors analyze the relationship between financial markets and the real economy in the context of economic and financial cycles. For instance, Angeloni and Faia (2009), Christiano, Motto and Rostagno (2010), Meh and Moran (2010), Cúrdia and Woodford (2010), and Claessens, Kose and Terrones (2012) highlight the importance of including financial variables into real business cycles analyses in order to consider financial dynamics in the estimation of the effectiveness of monetary and fiscal policy.

Nevertheless, we highlight the relevance of also analyzing the effect of international financial conditions on the real economy. There is evidence to suggest that international financial conditions have consequences on national financial markets and the real economy. These consequences are especially important during periods of financial distress where pass-through events and financial contagion can arise, as emphasized by Balakrishnan, et al. (2009).

Since many variables such as asset prices, interest rates, bonds, derivatives, among others, may potentially determine national or international financial conditions, we could summarize the information contained in them by means of an appropriate index. Hence, we analyze if the performance of international stock markets affect macroeconomic conditions in Colombia. To accomplish this objective, we first estimate financial conditions indices (FCIs) for developed and emerging economies using their national stock market indices.

Subsequently, we analyze the impact of international stock market conditions on the economic activity in Colombia using a factor-augmented vector autoregression (FAVAR) analysis as proposed by Stock and Watson (2002a) and Bernanke, Boivin and Eliasz (2005). We perform this analysis by differentiating between financial conditions of developed and emerging countries.

Our main results show that stock market conditions of emerging economies have a positive effect on economic activity in Colombia. In contrast, we find that financial conditions of developed economies do not have a statistically significant effect on economic performance in Colombia.

This paper is organized as follows. In section I, we present the literature review. Section II contains the methodology and econometric framework employed in the analysis. In section III, we present the data, and in section IV the estimation results. The last section concludes.

I. Literature Review

A financial conditions index compiles information on different financial variables that affect the economy’s performance. In the last thirty years, many authors have explored and developed the estimation of FCIs, identifying two different approaches to their construction.

One approach consists of the estimation of FCIs considering only a few financial factors chosen among a wide group of variables, according to a theoretical framework or the researcher’s necessity. Weighted averages of cross correlations of variables and a CAPM approach are some of the methodologies that researchers use to estimate FCIs in this fashion. Balakrishnan et al. (2009) use these methodologies to estimate joint FCIs for developed and emerging economies. These authors construct a measure that summarizes and describes the financial dynamics of a group of countries according to their classification into developed or emerging markets. Although the indices estimated by these authors permit to analyze some important aspects of the financial performance of the economy, in many cases they do not reflect the complexity of the dynamics of such conditions. Hence, FCIs estimated taking into account a limited number of factors could potentially misestimate the financial performance of the overall economy.

Lecturas de Economía -Lect. Econ. - No. 85. Medellín, julio-diciembre 2016 Mosquera, Restrepo and Uribe: Effects of Stock Indices of Developed and Emerging...

An alternative estimation approach considers as many factors as possible, exploiting the information available regarding financial conditions. Moreover, under the hypothesis that many international variables influence the financial performance of a specific economy, it is convenient to consider as much information as possible in order to capture the dynamics of the financial environment of the economy. This approach considers different methods that reduce the dimension of the information set, incorporating several factors in the construction of the financial indices. These models are known as factor models, and the most common methodologies to estimate them are principal components analysis (PCA) and singular value decomposition (SVD).

Stock and Watson (2002a), Hatzius et al. (2010) and Gómez et al. (2011) use principal components methodologies to estimate FCIs for different economies. All these studies consider several variables to build an FCI that properly describes the dynamics of financial conditions of the economies studied.

Since most of the financial variables are available on a high frequency basis, Brave and Butters (2011) estimate a high frequency FCI for Norway and the United States using dynamic factor models. The methodology proposed by the authors considers cross-correlations between variables, and the estimated index captures well-known episodes of crashes and crises.

Gómez et al. (2011) use factor models to estimate an FCI for Colombia.

These authors construct the index considering financial variables such as interest rates, credit aggregates and expected inflation surveys. These authors evaluate the performance of the estimated index as a leading indicator and by its capacity to predict the behavior of some macroeconomic variables.

Regarding the effect of the FCI on the performance of the real economy, Stock and Watson (2005) propose a methodology to predict the behavior of macroeconomic variables using indices estimated by factor models.

This method, called FAVAR, attempts to measure the impact of the behavior of different sectors on macroeconomic variables by combining the indices estimated through PCA with a vector autoregression analysis.

This methodology permits to capture the international interaction within financial markets by analyzing the effect of the FCIs, estimated using as much information as possible, on the performance of the economy. Therefore, we aim to analyze the influence of stock market conditions of developed and emerging countries on Colombia’s economy. To summarize international financial conditions, we estimate an FCI for a group of developed and emerging countries using dynamic factor models. These models permit to include as many countries as possible in the sample. Then, we analyze the influence of the performance of international stock markets on Colombia’s real activity using a FAVAR approach.

II. Methodology



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