World Asset Markets and the Global Financial Cycle: Dynamic Hierarchical Factor Model Approach

Global Financial Cycle is a phenomenon of strong positive correlation all over the world in such variables as capital inflows and outflows, leverage of financial intermediates or prices of different risky assets. I devote this work to the latter type of variables and employ dynamic hierarchical factor model in order to extract the global factor which drives the returns of assets in different regions. Starting with the replication of Miranda-Agrippino and Rey (2015) who found the factor to explain 21.5% of variation in returns on different assets, I proceed with my own identification. I find that there exists one global factor which, on average, explains up to 8.5% of variance in returns of different assets including equity, government bonds, corporate debt and real estate. The factor reflects important events for the global economy and is negatively correlated with VIX, an index of implied volatility of options, although only during downturns. US monetary policy shocks significantly negatively affect the factor and account for 10% of its variance. Overall, my results evidence in support of the global financial cycle in prices of risky assets.