The stance of US monetary policy appears to have a lagged effect on leverage and risk aversion, and risk aversion has a contemporaneous effect on the price of risk. In turn, the price of risk in the US is related to the price of risk internationally, including the premium on emerging market bonds.
Panel A, in the Figure, shows that the stance of US monetary policy (measured by the Federal Funds rate) causes a lagged response in risk aversion (as measured by the VIX). It may be argued that correlation is not causality, but no central bank can yet claim to have ever targeted financial conditions in a forward looking way.
Panel B shows that the stance of monetary policy also has a lagged effect on leverage (measured by the debt to equity ratio in US manufacturing corporations).
Risk is a commodity like any other one. There is no reason for the price of risk not to be related internationally. Panel C shows a contemporaneous relationship between risk aversion in the US (the VIX), the price of risk in the US (the US high yield), and the price of risk in emerging market bonds (the EMBI spread).
It could be argued that it is not correct to compare the implicit volatility of stocks (the VIX) with the price of risk in US and EM bonds (the US high yield and the EMBI spread). However, US stocks, high yield US bonds and EM bonds are all risky compared to US bonds, and as long as these different spreads move in the same direction, and in the same direction as the VIX, as they seem to have done in the past, the VIX can be used as a an indicator of greater or lesser risk in all markets.
Risk aversion changes the price of risk in emerging markets in all regions. Panels D, E, and F show a contemporaneous positive relationship between risk aversion and the price or risk in EM bonds in five regions.
In short, Figure 1 shows that emerging markets are not an isolated segment of financial markets but an integral part of the global village, and that the stance of US monetary policy has to do with the price of risk internationally and in particular with the risk premium on emerging market bonds.
*Based on a box of the book Dinero, banca y finanzas, Los países emergentes en la economía global (Money, Banking and Finance, Emerging Economies in the Global Economy, forthcoming).