U.S. And China Monetary Policy Uncertainty, Financial Stress and GCC Sectoral Risk: Do These Shocks Intensify GCC Sectoral Risk Contagion?

Abstract

This study explores the transmission of shocks from the Financial Stress Indices (FSI) and Monetary Policy Uncertainty (MPU) in the United States and China towards the Gulf Cooperation Council (GCC)’s sectoral risk. It employs the time and frequency domain Generalized Vector Autoregressive (GVAR) networks. The time domain GVAR approach suggests that China's MPU, U.S.-MPU, and U.S.-FSI act as the net shock transmitters. The frequency domain GVAR suggested that the U.S.-MPU transmits the highest shocks to all GCC sectoral risks, surpassing the Chinese MPU and FSI in the short-, medium- and long-term investment horizons. Additionally, the transmission of shocks from the U.S. and Chinese MPU and FSI to the GCC sectoral risk exceeds the shocks transmitted by the GCC sectors to each other in the short, medium and long-term. To investigate the moderating impact of the FSI and MPU in the U.S. and China on the GCC sectoral risk contagion, we re-estimated the volatility connectedness between the GCC sectors by using the frequency domain GVAR approach. The results show that China's FSI and MPU significantly amplify the short-term GCC sectoral risk contagion, while the U.S.-FSI significantly intensifies the GCC sectoral risk contagion across all investment horizons in the presence of oil supply, oil demand side shocks and the global real economic activity shocks as control measures. Finally, we employ the DCC-GARCH-t copula approach and find that short-term positioning in the material sector is most cost-effective option for hedging long-term volatility in most GCC sectors during the heightened U.S.-MPU and FSI regimes.

Keywords: Monetary Policy Uncertainty, Financial Stress, Risk Contagion, Time and Frequency Domain Connectedness, Hedging Effectiveness