Financial Stress, Regime Switching and Spillover Effects: Evidence from a Multi-Regime Global VAR Model

The globalization process leads to increasing synchronization of business cycle among different countries. As a consequence, many policy makers and Central Banks are afraid of vulnerabilities of their country arising from exter- nal risk drivers. In this paper we develop a multi-regime global VAR model to study the spill-over effects in financial markets, in goods markets and between financial markets and good markets across countries, which are assumed to be in a high financial stress regime or a low financial stress regime. It turns out that in both high and low stress regimes financial shocks to a country, big or small one, can have large and persistent impacts on financial markets of other countries, and only in the high stress regime financial shocks to a country can have some negative output effects on other countries. In high stress regime output shocks of a big country can have larger effects on finan- cial stress than those of a small country, while in a low stress regime output shocks of a country, big or small, have little impact on financial conditions. Further, we study the effects of global and regional shocks, as well as the spillover effects of national monetary policies and internationally coordinated policies on the financial and real sectors.