The Impact of Financial Market Volatility on Emerging Market Economies

Early in the New Year, economists from all over the world will congregate in Boston for the 2015 annual meetings of the American Economics Association. The main purpose of these meetings is to interview new Ph.D. candidates for potential jobs as academics and in the public and private sectors as research and/or policy economists.  

Sangyup Choi

As an academic economist at UCLA, my job includes teaching undergraduates, carrying out economic research for publication in books and journals and, (my favorite part), training new Ph.D. economists. Teaching graduate students is a rewarding experience for an academic as we get to watch our students progress from undergraduates to colleagues. What begins as a teaching experience in year 1 ends up as a learning experience in year 5. 

Today's blog features my student, Sangyup (Sam) Choi, who is working on  the impact of financial market volatility on emerging market economies.  My colleague Aaron Tornell and I are Sam's principal advisors.

Sam is studying the VIX and its impact on economic activity. This is a hot topic amongst macroeconomists ever since Nick Bloom showed, in a paper published in Econometrica,  that shocks to uncertainty are a causal factor in US. recessions. What, you ask is the VIX?


The VIX is an index of volatility that goes up when traders are less certain about the future. In his Econometrica paper, Nick showed that shocks to the VIX are an independent causal factor that helps to predict future U.S. output. Here is a graph of the VIX for the period 2000 to 2014.

Figure 1: The VIX from 2000 to 2014

In a paper published last year in Economics Letters, Sam showed that Nick’s results are sensitive to the period of study. The VIX does predict future output in data from 1950 through 1982, but that result goes away after 1983. The largest recession in post war history in which the VIX jumped by a factor of four, (see Figure 1), did not have a significant independent impact on the U.S. economy, once other explanatory variables have been accounted for. That in itself is surprising. But it gets better.

In his most recent work, Sam has looked at the impact of the VIX on emerging market economies. He finds that although shocks to the VIX do not have much impact on US output, they do have a noticeable impact on the output of emerging market economies. Figure 2 presents the evidence for that claim.

Figure 2: The Impact of a VIX shock on the U.S. & Korea (c) Sangyup Choi

In Sam’s own words.

My job market paper, entitled “The real impact of VIX shocks on emerging market economies: flight to quality mechanism,” starts from an observation that fluctuations in the VIX have had a much larger impact on emerging market economies than they have had on the US economy for the last two decades.  This finding is puzzling as the VIX measures U.S. stock market volatility. 

To understand why an increase in the VIX has a much larger impact on output fluctuations in emerging market economies than on the U.S. economy, I build a small open economy model with credit market imperfections. The model incorporates a portfolio decision by international investors and an increase in the VIX makes these investors withdraw their funds from emerging markets. 

In Sam’s theory, VIX shocks, in a world of integrated capital markets, cause investors to pull their money from emerging markets. Because emerging market economies have poorly developed credit markets, the sudden outflow of cash causes domestic firms to cut back on production and lay off workers.

Back to Sam…

[In my dissertation] … I build a theoretical model that helps understand my empirical findings.

… I confirm the prediction of my model by estimating structural Vector Autoregressions using data from 18 emerging market economies between 1994 and 2013. … I find that VIX shocks are followed by a statistically significant increase in the real interest rate, a fall in domestic credit, and a real currency depreciation. In contrast, in the U.S. economy VIX shocks are followed by a (statistically insignificant) fall in the real interest rate, an increase in domestic credit, and a real currency appreciation.

…the new empirical findings from my two papers expand our understanding of the importance of uncertainty shocks. When combined with credit market imperfections, the VIX serves as a real-time indicator of risk to emerging market economies.

Here is a link to the online appendix to Sam's paper, which has a dazzling array of evidence to support his claim.

Sam is a terrific economist and will make a great colleague. Hire him! You won't be disappointed.