Global Shocks and Local Impacts: A Diebold-Yilmaz Spillovers Analysis of the US, Commodity Markets, and Pakistan

Abstract

This paper examines the transmission of the macroeconomic and financial shocks from the United States to the global commodity markets and Pakistan by using a comprehensive monthly data set for the period January 2007-August 2021. Using the advanced spillover index framework of Diebold and Yilmaz (2012) based on generalized forecast error variance decomposition (GFEVD) of a Vector Autoregressive (VAR) model, we then build a six variables system of the Pakistani rupee–US dollar exchange rate, domestic inflation in Pakistan, US interest rates, the US Dollar Index (DXY), global volatility (as proxied by the VIX), and Brent crude oil prices. The empirical results indicate that the total spillover index is 20.62% at the 10-month forecast horizon, the corresponding value of the degree of connectedness is moderate, but not negligible from the economic point of view. The VIX is the biggest net transmitter of shocks (+2.74%), followed by the PKR/USD exchange rate (+1.42%) and the DXY (+1.20%). On the other hand, oil prices are net receivers of spillovers along with Pakistani inflation (−2.11%) and US interest rates (−1.59%). The results have significant implications at the level of monetary policy design, exchange rate policy, and risk management strategies for emerging market economies with limited financial markets and high external vulnerability.

spillover index, exchange rate, VAR, generalized forecast error variance decomposition, emerging markets, Pakistan, commodity prices, volatility transmission