DP3759 Common Vulnerabilities
We pursue the idea that a region presents a common ?prospectus? to investors and lenders. Specifically, we explore whether investors respond to regional developments, rather than to country-specific fundamentals. Such behaviour may be appropriate where regions are identified by common development strategies and economic policies, and the costs of country-specific analysis exceed the returns. Using dynamic factor analysis, we estimate a common regional component of the exchange market pressure index (EMPI) as a measure of regional vulnerability. We find that a high level of regional external liabilities and exuberance in domestic stock and credit markets generates regional vulnerabilities, which are heightened when the US High Yield Index is also on the rise. Country-specific movements of the EMPI are also explained by the same regional indicators rather than by the country-specific components of these indicators.
