The comovement of bubbles’ responses to monetary policy shocks

• Published in: The North American journal of economics and finance 2024-09, Vol.74, p.102244, Article 102244
• Main Authors: Caraiani, Petre, Călin, Adrian Cantemir
• Format: Article
• Language: English
• Subjects: Bubbles; Dynamic Factor Model; Monetary policy; VAR
• ISSN: 1062-9408
• DOI: 10.1016/j.najef.2024.102244

In this paper, we present a two-step methodology designed to elucidate the extent of co-movement in the behavior of asset bubbles across a selected group of developed and emerging economies, with observations extending from the year 2000 onwards. We characterize the behavior of these bubbles, conceptualized as the disparity between fundamental and market values, by examining their responses to monetary policy shocks. Our investigation into their co-movement dynamics post-2000 involves the estimation of a Bayesian Dynamic Factor Model that incorporates the reactions of asset bubbles to monetary policy shocks, both in the short term and the long term. Notably, our findings reveal a convergence in short-term responses among these bubbles prior to the onset of the financial crisis. However, as the crisis unfolded, our results indicate a shift towards divergence. Concerning the long-term response of bubbles to monetary policy, divergence was observed before the crisis, but once the crisis had taken hold, there was a noticeable trend towards convergence. An influential idiosyncratic factor was identified for countries like the United States, South Korea, and Japan, impacting both short-term and long-term behavior. Conversely, the long-term behavior of bubbles in most emerging economies appears to be influenced by idiosyncratic factors. Furthermore, our results largely maintain their robustness even when utilizing an alternative measure of monetary policy stance during the period of the zero lower bound. Nevertheless, this secondary analysis suggests heightened volatility in the factors affecting both emerging and advanced markets. •We apply a time-varying BVAR to uncover the dynamic impact of monetary policy shocks on bubbles.•We use a sample of developed and emerging countries.•We further use the responses in a dynamic factor model to study the comovement of the bubbles.•There is a convergence in the short-term responses before the financial crisis in 2007–2009.•The idiosyncratic component of the bubbles responses is strong for several countries, including the US, Japan.•The results are largely robust to different robustness tests.