Country Transparency and the Global Transmission of Financial Shocks

IMF Working Papers, July 3, 2013

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Canonical URL: Country Transparency and the Global Transmission of Financial Shocks

Paper examines the role of country-level opacity (the lack of availability of information) in amplifying shocks emanating from financial centers.
Provides a simple model showing that, in the presence of ambiguity (uncertainty about the probability distribution of returns), prices in emerging markets react more strongly to signals from the developed market the more opaque the emerging market is.
Presents empirical evidence for bond and equity markets consistent with the model's prediction.
Policy implications highlight that increasing the availability of information about public policies, improving accounting standards, and enhancing legal frameworks can help reduce adverse side effects of financial globalization.

Core mechanism: ambiguity about return distributions leads investors to overweight signals from developed markets when valuing assets in more opaque emerging markets.
Resulting effect: greater sensitivity of emerging market prices to shocks originating in financial centers as opacity increases.

Evidence is provided for both bond and equity markets that aligns with the model’s prediction that higher country-level opacity amplifies transmission of financial shocks.
Empirical work draws on indicators and variables such as country MSCI index, country risk, dividend yield, sovereign bond index return, and PricewaterhouseCoopers' Opacity Index (PWC Opacity Index).

Increase the availability of information about public policies.
Improve accounting standards.
Enhance legal frameworks.
Aim: mitigate the amplification of global financial shocks transmitted to emerging markets.

Appendix A – Model Details and Proofs
- Appendix A – Model Details and Proofs (Markdown version)
- Appendix A – Model Details and Proofs (PDF)