Common and idiosyncratic factors of business cycles connectedness

Luciano Campos, Jesús Ruiz Andújar

2019-11-28 - The spillover indexes developed by Diebold and Yilmaz, 2009, 2012, 2014, 2015ª have become popular tools in measuring financial and macroeconomic connectedness. This paper proposes to complement this methodology with a dynamic factor model that disentangles between common and idiosyncratic components affecting the system connectedness. We apply the model to Latin American business cycles and show that our method allows a richer interpretation than the original setup. In particular, we find that business cycles connectedness rise significantly during global recessions mostly due to the common factor. These findings support the usefulness of policy coordination among Latin American economies to cushion the spillover effects of exogenous shocks. Though a clustered and a pairwise analysis suggest that some countries are more suitable than others for policy coordination.