News Shocks across Countries: An Empirical Investigation

Abstract

We estimate the role of news shocks to total factor productivity, foreign interest rates and commodity terms of trade in explaining the variance of output and other macro aggregates in a large sample of countries. To correct for the small-sample bias of the variance decomposition estimates we develop a Bootstrap-after-Bootstrap method. We find that the mean difference of variance share of output explained by news shocks between developing and developed countries is: I) Negligible for news shocks to total factor productivity. II) Positive for news shocks to foreign interest rates (6 p.p.) and to commodity terms of trade (8.3 p.p.). Using cross-sectional data, we find that countries with less financial development have a larger share of output variance explained by news shocks to foreign interest rates, and countries with higher total trade of commodities to output ratio and less developed financial markets exhibit a larger share of output variance explained by news shocks to commodity terms of trade. These results suggest that to study the role of news shocks in the economy, one-sector models with only shocks to total factor productivity are not adequate, and that there must be a structural distinction regarding financial markets' development when modeling developing countries as opposed to developed in a general equilibrium framework.