Global liquidity, market sentiment, and financial stability indices

This paper investigates the determinants of global liquidity, measured using BIS data on cross-border claims of banks (bank flows) in a sample of 149 countries. The main contribution of our paper is in identifying the link between global liquidity and a variety of market sentiment and financial stability indices. Using panel regressions incorporating country fixed effects, we find that the CBOE Volatility Index (VIX), FRED and Bloomberg Financial Stability Indices, the US Conference Board Leading Economic Index, US TIPP Economic Optimism Index, and KBW Indices all appear relevant in capturing the magnitude of changes in cross-border global liquidity. We corroborate previous empirical evidence that bank conditions and monetary policy in important financial centres, in particular, the USA remain highly significant in determining cross-border bank flows. Cross-border bank flows relate positively to the Effective Federal Funds rate, US Treasury yield, and US prime rate of banks, and are negatively correlated with the slope of the US yield curve, and the US TED spread. Additionally, the UK monetary policy (UK target rate) and financial conditions (slope of the UK yield curve) are also important in determining global liquidity, a finding which contributes to the literature by emphasizing non-US drivers of bank flows. Financial market factors (“push” factors), in particular, stock market turnover ratios (value traded/capitalization), and macroeconomic indicators (country-specific “pull” factors) such as the GDP deflator, inflation, and government debt also impact on cross-border bank flows. The results are robust to changes in the estimation methodology and varying sets of the control variables.