Emerging markets "are increasingly relevant to global finance as sources and conduits of financial shocks” and therefore have rising influence on global financial stability, the study found.
Although advanced and emerging economies are both experiencing greater “to” and “from” spillovers in volatility and aggregate equity return, emerging markets, particularly China, are the biggest influencers.
As financial linkages strengthen, the role of emerging markets as shock givers is expected to grow, the study said.
China as shock giver
During the second half of 2015 China's markets tanked and global markets followed. The study examined this period to highlight the massive jump in China’s impact according to the Connectedness Index, which measures market shock correlation.
The authors pointed out that the Connectedness Index soared in recent months compared to the taper tantrum of May-July 2013.
Connectedness Index* from China to selected countries
Note: Net directional returns.
*The Diebold-Yilmaz Connectedness Index
Source: "Dynamic Connectedness of Asian Equity Markets" an IMF working paper.
Unsurprisingly, since 2015 China's impact on key markets was strongest in Hong Kong, as the two jurisdictions increasingly link their markets and financial systems:
Source: "Dynamic Connectedness of Asian Equity Markets" an IMF working paper
“China’s equity returns contributed to a larger share of the movements in other equity markets in 2015 and into early 2016, especially as news originating from China impacted its own domestic market as well as markets worldwide.
“This is in sharp contrast to Japan, whose contribution to other equity market movements has been steadily declining over the same period. Furthermore, China’s equity market, on a net basis, contributes far more in terms of shocks to other markets than it receives starting from the second half of 2015.”
China's slowdown in GDP growth, pullback in demand for commodities and the fall in commodity prices are playing a big role in transmitting market shocks across borders.
“News about economic prospects in China originating in China’s equity markets are then transmitted to commodity price and equity prices of other EMs, including commodity importers. In this way, equity prices act as a conduit of shocks across broader global markets.”
The analysis “confirms the growing importance of China as the net source of financial shocks”, according to the authors.
The study, “Dynamic Connectedness of Asian Equity Markets” was conducted by Roberto Guimarães-Filho and Gee Hee Hong and is a working paper for the IMF.