The Synergy of Financial Volatility Between China

sustainability
Article
The Synergy of Financial Volatility between China
and the United States and the Risk Conduction Paths
Xiaochun Jiang 1 , Wei Sun 1 , Peng Su 2, * and Ting Wang 3
1 Center for Quantitative Economies, Jilin University, Changchun 130012, China
2 School of Management, China University of Mining and Technology, Xuzhou 221116, China
3 School of Economics, Jilin University, Changchun 130012, China
* Correspondence: [email protected]

Received: 12 July 2019; Accepted: 30 July 2019; Published: 1 August 2019
Abstract: Based on monthly data of six major financial variables from January 1996 to December 2018,
this paper employs a structural vector autoregressive model to synthesize financial conditions indices
in China and the United States, investigates fluctuation characteristics and the synergy of financial
volatility using a Markov regime switching model, and further analyzes the transmission paths of
the financial risk by using threshold regression. The results show that there is an approximately
three-year cycle in the financial fluctuations of both China and the United States, and such fluctuations
have a distinct asymmetry. Two thresholds were applied (i.e., 0.361 and 0.583), taking the synergy
index (SI) as the threshold variable. The impact of the trade factor is significant across all thresholds
and is the basis of financial linkages. When the SI is less than 0.361, the exchange rate factor is the
main cause of the financial cycle comovement change. As the financial volatility synergy increases,
the asset factor and interest rate factor start to become the primary causes. When the level of synergy
breaks through 0.583, the capital factor based on stock prices and house price is still the main path of
financial market linkage and risk transmission, but the linkage of monetary policy shows a restraining
effect on synergy. Therefore, it is necessary to monitor the financial cycle and pay attention to the
coordination between countries in terms of policy regulation.
Keywords: financial cycle; synergy; structural vector autoregression; Markov regime switching
model; factor analysis; threshold regression
1. Introduction
In the context of rapid economic growth and stable inflation, both Japan in 1990 and the United
States in 2007 experienced large-scale capital market crashes. Severe credit contraction and shrinking
asset prices triggered a long-term recession. The two crises made academics and policymakers aware
that it is not sufficient to maintain economic sustainability without paying attention to financial market
volatility [1,2]. The history of financial crises shows that most occur near the peak of the financial
cycle. Moreover, the correlation between economic cycle and financial volatility is becoming closer.
A financial crisis is often accompanied by a recession, and the financial expansion period often leads
to credit expansion and is accompanied by economic recovery [3]. However, the traditional cycle
theory based on the real business cycle fails to adequately consider the risk perception of banks and the
cycle of asset prices. Therefore, it is difficult to reasonably explain the cyclical fluctuations of financial
markets and to accurately capture the financial cycle changes [4].
Having reflected on the global financial crisis, Borio [5] proposed the concept of the “financial cycle”.
The financial cycle is the result of the interaction between financial conditions such as credit constraints
and the value of financial assets. The credit growth and real estate prices are the main elements,
which can link the financial and real economy through channels such as balance sheets, leading to
Sustainability 2019, 11, 4151; doi:10.3390/su11154151 www.mdpi.com/journal/sustainability

Sustainability 2019, 11, 4151 2 of 22
procyclical fluctuations in finance. When the economic cycle and financial cycle are superimposed
simultaneously, the magnitude of economic expansion or contraction will be enlarged. When the
economic cycle and the financial cycle are not synchronized, the direction of their roles may be different
or even opposite. If those in charge of policymaking are not aware of the importance of risk appetite,
credit constraints, and asset prices to the macroeconomy, and ignore the financial cycle, the regulatory
policies implemented to curb the real economy recession are likely to cause risks related to financial
imbalances. The theory of the financial cycle has become a new paradigm that is designed to fit the
cyclical fluctuations of the macroeconomy under the modern financial system.
Driven by recent economic globalization and financial integration, the correlation between the real
economy and the financial environment among countries has increased significantly. Especially during
the outbreak of the US financial crisis, financial risks spread rapidly among financial markets in
various countries, which eventually led to a global economic recession. Therefore, on the basis of
analyzing and testing the fluctuation situation and the operation characteristics of the financial cycle,
it is necessary to further explore the law of synergy among the financial cycles of various countries,
which will help countries to carry out international measures of cooperation in financial relations and
real economic regulation.
China, a developing country with the fastest economic growth rate in the world, and the United
States, a developed country with the largest economy in the world, have played a vital role in global
financial and economic development in recent years. According to World Bank data [6], the contribution
rate of major countries and regions to world economic growth from 2012 to 2016 is 10% in the United
States and 34% in China. The financial and economic relationship between China and the United States
not only helps to encourage the stable and healthy development of the economies of both countries,
but also has a guiding and transmitting role that cannot be ignored for the economic and financial
market stability of other countries. In the event that the internal economic or financial markets of China
and the United States are out of balance, imbalance within the world economy is inevitable. Therefore,
studying the characteristics related to volatility within the financial cycle observed between China
and the United States, as well as its coordination mechanism, can not only provide useful empirical
evidence and policy implications for the reform and development of China’s financial system, but can
also be of significant value in terms of maintaining global financial stability and economic sustainability.
This paper aims to analyze the synchronization between the financial cycles of China and the
United States, and discuss its transmission path. Specifically, this paper selects six types of financial
indicators, including the interest rate, credit, money supply, house price, stock price, and exchange rate
for the period January 1996 to December 2018 in China and the United States, in order to synthesize the
financial conditions index (FCI), the fluctuations can be used to measure the financial cycle. The weights
of the financial indicators used in the FCI are determined by the structural vector autoregressive (SVAR)
model and the impulse response function (IRF). The Markov regime switching model is then used to
identify the turning points of the respective FCI series of the two countries to complete the division of
the cycle. Furthermore, we use the rolling consistency index and correlation coefficient to measure the
synergy of financial cycles between China and the United States. Finally, considering that there may
be differences in the factors affecting the synergy of financial cycles between China and the United
States in different periods, threshold regression is used to empirically analyze the factors affecting
the synergy.
The structure of the paper is as follows: Section 2 presents a literature review; Section 3
describes the dataset, variables, and methods used; Section 4 presents the main results, and Section 5
discusses the conduction path of financial cycle synergy. Finally, Section 6 outlines some conclusions
and observations.
2. Literature Review
The study of the financial cycle can be traced back to the debt–deflation theory proposed by
Fisher [7] during the Great Depression, which argues that excessive debt and deflation will interact
and spiral upward, causing a recession. However, the Keynesian economic cycle theory based on
the IS (Investment-Saving equation)–LM (Liquidity preference-Money supply equation) framework
was the main paradigm in the field of macroeconomic cycle research. The Keynesian school divided
macroeconomics into short-term fluctuations and long-term growth trends. The short-term real
economy volatility represented by real GDP is a deviation from the long-term potential GDP trend.
The two oil crises and the lack of explanation for the stagflation led to a questioning of Keynesianism
by the neoclassical macroeconomics advocated by Lucas [8]. After the 1980s, the real business cycle
theory that used exogenous practical factors to explain the root causes of economic cycle fluctuations
became the core of neoclassical macroeconomic theory [9,10]. However, both the Keynesian economic
cycle theory and the real economic cycle theory (hereinafter referred to as the “traditional economic
cycle theory”) ignore the role of financial friction in the macroeconomy. The outbreak of the global
financial crisis in 2007 exposed the shortcomings of traditional economic cycle theory, which focuses
only on the fluctuation of the real economy, but sets up the financial market too simply [11], resulting in
a disconnection from real macroeconomic development.
The profound lessons of the global financial crisis have led economists to realize that mature
economies are likely to be swallowed up overnight by seemingly prosperous financial illusions,
with greater damage and longer recovery periods [5]. Bernanke et al. [12] revised the premise of
financial neutrality theory, and the important role of financial factors in the economic cycle was
established. Subsequently, a large number of studies have shown that the volatility of the financial
system not only delays the natural regression of the macroeconomy to its stable state, but may
also generate an accelerator effect or procyclical effect, which amplifies the fluctuation of the real
economy [13–16]. The measurement of the financial cycle and related research then began to appear
and continued to increase [16–18]. Based on these empirical findings, Borio [5] formally proposed the
concept of financial cycles in 2014.
Comparable to the traditional economic cycle, there are also medium- and long-term low-frequency
fluctuation components and short-period high-frequency fluctuation components in the financial
cycle fluctuations. The characterization of low-frequency fluctuations in the financial cycle is mostly
concentrated on real estate prices or credit cycles [19–21]. The variation of these variables is dominated
by low-frequency fluctuations, and their wavelengths and amplitudes are larger than the traditional
economic cycle. Due to the strong correlation between these variables and the macroeconomy in the
medium and long term, the financial cycle measured by these variables is usually accompanied by a
financial crisis after the peak. Therefore, the monitoring of such low-frequency fluctuations tends to
identify the risk of future financial distress or financial crisis in advance.
The research on high-frequency fluctuations of the financial cycle mainly extends consideration
to other financial variables, such as stock price, money supply, interest rate, and exchange rate,
and constructs the financial conditions index (FCI) [22] by combining multiple financial variables or
extracting common components from them using statistical methods to investigate the cyclical changes
of the overall financial environment [23,24]. This type of research not only introduces high-frequency
financial variables, but also takes into account the fluctuations of financial variables in different
fields, so the length of the financial cycle is generally consistent with or even shorter than that of the
macroeconomic cycle.
The high-frequency volatility component of the financial cycle reflects the interaction between
financial factors and the macroeconomy. It not only reveals the volatility of the financial market under
various internal and external shocks, but also reflects the dynamic response of monetary policy and
other financial policies to the economic and financial environment. Therefore, considering that the
purpose of this study is to analyze the synergy of financial volatility between China and the United
States, we chose to develop an FCI with high-frequency factors to measure the financial cycle.
In recent years, the method of using multiple financial indicators to synthesize an FCI to measure
the overall financial situation has been widely recognized by domestic and foreign academic circles.
In fact, the financial stress index (FSI) [25,26] that reflects the risk pressure of the financial system is
also widely used. However, the FCI can be used as a leading indicator to predict the future state of
other macroeconomic indicators because it contains financial variables that reflect future economic and
inflationary information. Compared with FSI, FCI is more macroscopic. This is consistent with the
original intention of this paper—to study financial risk transmission to maintain economic growth and
stability. Therefore, the paper chose to use FCI.
From the point of view of the existing literature, the calculation methods of the FCI are mainly
divided into two types: extracting common components from various financial indicators and
weighting of a combination of financial indicators. The former mainly uses principal component
analysis, factor analysis, and a dynamic factor model [27,28] to extract the FCI index from multiple
financial indicators. For example, Brave and Butters [29] used principal component analysis to extract
the US FCI from a large number of financial indicators, and found that the calculated FCI can be
used as an important basis for policy formulation and financial market evaluation. Matheson [30]
used the dynamic factor model to synthesize the FCI of the United States and the European Union.
The advantage of this method is that it captures more financial indicators and is not limited by specific
theoretical assumptions, though it is disadvantageous as it ignores the correlation between financial
indicators and macroeconomic target variables.
Thus, more scholars tend to determine weights according to the relationship between financial
variables and macroeconomic target variables (such as inflation), and calculate the FCI by using a
weighted combination of multiple financial indicators. There are roughly three kinds of methods to
determine the weight of financial indicators using this type of calculation method. One method is to
use the estimated values of coefficients in the large-scale macroeconomic simultaneous model as the
basis for determining the weight of financial indicators. Dudley and Hatzius [31] estimated the impact
of financial variables on gross domestic product (GDP) based on the large-scale macroeconomic model
of the Federal Reserve, and used it as a weight to calculate the FCI of the United States. The second is
to calculate the weight according to the estimated value of each financial variable coefficient in the
simplified total demand equation. Montagnoli et al. [32] used this method to calculate the weights of
various financial factors and synthesize the FCI in the United States, the United Kingdom, Canada,
and the European Union. Wang [33] also used the same method to calculate China’s FCI. The third
is to calculate the weight by using the cumulative impulse response of each financial variable to the
target variable, such as inflation in the vector autoregressive (VAR) system. Swiston [34] calculated
the US FCI by constructing a VAR model containing variables such as stock price, exchange rate,
and loan standard, and found that it has a good predictive effect on economic growth. This method not
only ensures the coverage of financial indicators, but is also advantageous as it is simple to calculate
and is not dependent on the assumptions of economic theory, and thus has been the most widely
used. Chinese scholars Feng et al. [35], Xu et al. [36], and Deng [37] also conducted a series of studies
based on this method. This paper will also use the third method to calculate the FCI. Taking into
account the contemporaneous correlation between variables, the pulse function of the structural vector
autoregressive model is chosen to determine the weight of each financial indicator.
Although scholars have conducted substantial analyses of the financial situation of different
countries based on the FCI, the methods of measuring FCI are different, and the financial indicators
considered are also very different, which objectively hinders the study of financial cycles and their
linkage in different countries. So far, the research on international financial relations, especially the
characteristics of financial market linkages between China and the United States, is mostly limited to the
independent analysis of specific financial markets or financial indicators. For example, Xiang et al. [38]
studied the asymmetry of financial interdependence between China and the United States from three
perspectives: bilateral capital dependence, bilateral capital flow structure, and bilateral capital cycle.
Yu et al. [39] used the SVAR model to analyze the linkage between the currency market, the stock market,
and the foreign exchange market in China and the United States. As an attempt and a supplement to
the existing research, this paper intends to select six financial indicators, namely, real estate price, credit,
stock price, money supply, interest rate, and exchange rate to measure their financial situation indices
in a unified way. This study investigates the volatility characteristics and synergy of the financial
cycle of the two countries, and further explores the influencing factors of international financial risk
transmission under different levels of synergy. It is expected to provide an empirical framework and to
highlight policy implications for maintaining the dual stability of China and the world’s real economy
and virtual economy.
3. Indicators, Data, and Methods
3.1. Selection of Financial Indicators

In choosing and constructing the financial variables of the FCI, this paper follows two principles:
one is that financial variables play an important role in the transmission mechanism of monetary policy;
the other is that financial variables contain key information that can predict future macroeconomic
conditions. According to this principle, and referring to relevant literature [40,41], the financial
variables used to construct the FCI and the reasons for their selection are as follows:
Money Supply (MS) and Interest Rate (IR). As the main monetary policy tools of the central bank,
money supply will indirectly and interest rate will directly affect the use cost of money, and then
influence changes in the financial sub-markets, such as the stock market, through changes in the
discount rate.
Credit Loans (CL). As a total index reflecting financial support to the real economy and financial
and economic relations, total credit loans affect the economic behavior of enterprises and residents
mainly by changing the financing conditions of financial markets and then influencing the economic
and financial markets.
Exchange Rate (ER). Under the open economy, the effective exchange rate—as a weighted average
exchange rate weighted by the proportion of foreign trade—is not only a bridge between one country’s
currency and other countries’ currencies, but also an important link between the two countries’ prices.
Its changes will affect a country’s economic and financial situation by causing changes in the trade
balance, capital flows, and asset prices such as stock prices.
Share Prices (SP). Aside from foreign exchange assets and monetary assets, the composition of
residents’ assets increasingly encompasses other assets, such as stocks and real estate. The change in
the stock price index is not only related to the capital cost of a company, but also affects the family’s
financial and consumption situation through various channels, such as the wealth effect, so it is one of
the important financial indicators.
House Prices (HP). As financial assets include property, real estate is an important component
of residents’ investment portfolio. Furthermore, real estate is often associated with credit expansion.
The rapid rise of housing prices has greatly increased financial risks, although it can increase total
consumption through the “wealth effect” and stimulate investment in related industries, such as
cement and steel, to promote economic growth. Therefore, it is also a factor that must be taken into
account in measuring the financial market situation.
3.2. Description and Processing of Data

The monthly data relates to 276 months from January 1996 to December 2018, which are
selected as samples. If there are no special instructions, all of the data are derived from the CEInet
Statistics Database [42]. The database is a comprehensive economic database group. According to
its content and frequency, it is divided into nine sub-databases: China’s macro-monthly database,
China’s macro-annual database, China’s provincial macro-annual database, China’s Customs monthly
database, China’s County annual database, China’s urban annual database, the OECD (Organization
for Economic Co-operation and Development) monthly database and the OECD annual database,
covering the macroeconomy, industrial economy, regional economy, and world economy. All of the
data in the database were obtained from various statistical and publishing departments, with stable,
reliable, and authoritative sources.
The indicators used to describe China’s financial market include the broad money supply,
weighted average 7-day interest rate for interbank lending, total loans of financial institutions,
effective exchange rate, Shanghai securities composite index, and national average house price.
The indicators used to describe the US financial market include broad money supply, federal funds
real interest rate, total consumer credit, effective exchange rate, New York Stock Exchange (NYSE)
composite index, and housing price index. Since China’s interest rate is not completely marketized,
deposit and loan interest rates show marginal fluctuations and cannot fully reflect the real situation
of financial market transactions. Therefore, the weighted average 7-day interest rate for the national
interbank market is adopted as the proxy indicator of the interest rate. In addition, exchange rate data
was obtained from the official website of the Bank for International Settlements (BIS) [43], and the US
total consumer credit data derives from the Federal Reserve website [44].
All of the variables of the two countries are converted using their own consumer price indices,
and both price indices are based on the “monthly average price of 2010 = 100”. Among the six financial
indicators used, the interest rate and the effective exchange rate are reverse indicators, while the other
four indicators are generally in the same direction as the financial situation, so these two sequences
need to be converted into positive indicators. The interest rate is converted to current discount rates
using the formula ρt = 1/(1 + rt ), and the effective exchange rate is converted from the original
indirect price to the direct price by taking the reciprocal.
The data are then adjusted using the X-12-ARIMA seasonal adjustment program, and the cycle
components are obtained using the Hodrick–Prescott (HP) filter. The cycle component is actually a
gap value that deviates from the long-term trend, so it is also called the gap sequence. The use of
gap sequences to synthesize indices is a common practice in economic sentiment analysis, which can
eliminate the influence of the long-term trend of the variable on the judgment of its state. Finally, all gap
sequences are standardized to eliminate the dimension and fluctuation differences among variables.
Data processing is completed using Eviews10.0 software. The final standardized gap sequence is
expressed by Gapi ( i = 1, . . . , 6), and the corresponding financial indicators are shown in Table 1.
Table 1. Symbolic description of financial gap sequences.
Indicators MS IR CL ER SP HP
Symbols Gap1 Gap2 Gap3 Gap4 Gap5 Gap6
3.3. Methods
The empirical study of this paper will include three parts: the construction of the FCI,
the measurement of synergy, and the analysis of transmission pathways. The research methods
to be adopted in each part are described as follows.
3.3.1. Construction Method of the FCI

The formulas for calculating the FCI used to measure the financial cycle are as follows:
X6 X
FCIt = wi Gapit , wi = 1, (1)
i=1
where Gapit represents the gap sequence of the country’s ith financial index, with wi being its
corresponding weight.
Because the financial indicators used in the calculation of the FCI are all processed by de-trend
and standardization, the calculated FCI directly reflects the deviation of a country’s financial activities
from the equilibrium state. Specifically, if the value of the FCI is close to zero, it means that the financial
environment is in a moderate state; if the FCI is positive (negative), it means that the financial situation
is prosperous (recession); if the FCI is rising (falling), it means that the financial situation is getting
better (worse).
The key problem is how to determine the weight, wi . A mature method is to use the impulse
response function of the VAR model [34]. The weights are determined by measuring the cumulative
impact of financial variables on economic growth or inflation. By contrast, the SVAR model
not only retains the hypothesis of endogenous variables, but also takes into account the current
relationship between variables, so it is more reasonable to determine the weight of variables [36,37].
This paper chooses to use the inflation rate πt to form a seven-element SVAR model with six financial
variables. The reason for this is mainly based on the following two points: first, China’s GDP data,
which characterizes economic growth, can only collect quarterly data, and all data in this paper are
monthly data. Second, existing research [35,37] shows that the FCI is generally the leading indicator of
economic growth and is more consistent with inflation.
Thus, the following p-order SVAR model is firstly constructed:
Ayt = As0 + As0 yt−1 + · · · + Asp yt−p + But , (2)
where yt = (Gap1t , Gap2t , · · · , Gap6t , πt )0 ; A7×7 , (Asi )7×7 , and B7×7 are structural coefficient matrices;
and ut is the orthonormal unobserved structural innovations with E(ut u0 t ) = I7 . Since A is generally
invertible, the corresponding reduced-form VAR model can be obtained:
yt = A−1 As0 + A−1 As1 yt−1 + · · · + A−1 Asp yt−p + A−1 But = A0 + A1 yt−1 + · · · + Ap yt−p + εt , (3)
and the reduced form error structure is given by
Aεt = But or εt = A−1 But = Sut ,

(4)
E(εt ε0t ) = A−1 B(A−1 B)0 = A−1 BB0 A−10 = SS0 .
In order to obtain the uniquely determined estimates of the corresponding structural parameters
from the simplified parameter estimation, the problem of identification is often encountered [45]. If the
constraints are imposed on matrix A and matrix B, they are called AB-model, and the constraints on
matrix S are called S-model. The identifying restrictions embodied in the relations Aεt = But and
εt = Sut are commonly referred to as short-run restrictions.
Constraints usually come from economic theory, while mature and easily deterministic theories
are generally long run. Blanchard and Quah [46] proposed an alternative identification method using
restrictions on the long-run properties of the accumulated impulse responses. Based on the model (3),
these long-run constraints can be expressed as follows:
(I − A1 − A2 − · · · − Ap )−1 εt = Ψεt = Fut , (5)
where Ψ = (I − A1 − A2 − · · · − Ap )−1 is the long-run multiplier, which may be estimated using the
reduced form VAR parameter estimate. It is also evident that F = ΨS. The SVAR model that imposes
constraints on matrix F is called F model. Note that knowledge of A and B is sufficient to compute S
or F, but the converse is not true. The long-run identifying restrictions are specified in terms of the
elements of this matrix F, typically in the form of zero restrictions. The restriction fij = 0 means that
the accumulated response of the i-th variable to the j-th structural shock is zero in the long run.
Considering the economic significance of constraints, this paper chose F model to estimate the
weight wi of the FCI, i.e., long-run constraints are imposed on the SVAR model to satisfy the identifying
conditions. According to the principle of SVAR modeling, if there are k variables, at least k(k − 1)/2
constraints must be applied to the matrix F to be identified. Here, we have seven variables, so 21
constraints are required. A common setting method is to set F to the lower triangular matrix. However,
if the order of the variables is different, the economic meaning of the constraints will be different.
Hence, the ordering of variables is important.
The standardized financial gap variables used in this paper are all converted using the consumer
price index (CPI) and can be regarded as real variables. According to the principle of currency neutrality,
inflation has no long-term impact on them. At the same time, the calculation of the FCI weight is due
to the cumulative reaction of inflation to the impact of various financial variables, so it is assumed that
each financial variable has a long-term impact on inflation. Thus, the inflation rate πt is ranked as the
seventh variable. In addition, it is generally believed that policy variables have long-term effects on
other financial variables, while other financial variables do not easily affect policy variables in the long
run. Therefore, this paper ranks the broad money supply gap variable and the real interest rate gap
variable in the first and second positions. For other variables, the policy tendencies of the variables
are ranked in descending order, followed by the social credit loan gap, exchange rate gap, stock price
index gap, and house price gap. In fact, the order of the six financial variables is the same as the order
shown in Table 1. In the actual estimation, it will also be adjusted based on the estimation results of
the F matrix elements. If the element fij is not significant, it is adjusted to zero and fji set to non-zero.
The final form of F is set as follows:
MS IR CL ER SP HP π MS IR CL ER SP HP π
   
MS  f11 0 0 f14 0 0 0  MS  f11 0 0 0 0 0 0 
   
IR 
 f21 f22 0 0 0 0 0 
 IR 
 f21 f22 0 0 0 0 0 

CL  f31 f32 f33 0 0 0 0  CL  f31 f32 f33 0 0 0 0 
FCHN =

 , FUSA =
 
 .

(6)
ER

f42 f43 f44 0 ER


 0 0 0 


 f41 f42 f43 f44 0 0 0 

SP 
 f51 f52 f53 f54 f55 f56 0 
 SP 
 f51 f52 f53 f54 f55 f56 0 

HP f61 f62 f63 f64 0 f66 0 HP f61 f62 f63 f64 0 f66 0
   
   
   
π f71 f72 f73 f74 f75 f76 f77 π f71 f72 f73 f74 f75 f76 f77
The long-term constraints imposed by China and the United States are basically the same. The main
difference is reflected in the long-term effects between the money supply and the exchange rate, i.e.,
the setting of f41 and f14 . The reason for this setting is that China’s f41 is not significant and f14 is
significant, while the converse is true for the United States. Given the dominant position of the US
dollar in the international money market, this result is reasonable.
Based on the estimation results of the above SVAR model, the impulse response function is used
to further calculate the cumulative response of the inflation rate to the impact of each financial variable.
Considering that the short economic cycle is generally 3–5 years [16], this paper selects the cumulative
generalized impulse response value of 60 months. Finally, the weight of the i-th financial indicator in
the FCI is calculated according to the following formula:
6
X
wi = |zi |/ |zi | , (7)
i=1
where zi is the 60-stage cumulative generalized impulse response of inflation to the gap value of
financial variable, i. Thus, in conjunction with Equation (1), the calculation of the FCI can be completed.
3.3.2. Measurement Method of the Comovement

Before the analysis of the synergy between the financial cycles of China and the United States,
it is necessary to first divide the fluctuations of the two financial cycles. In the study of the traditional
economic cycle, a turning point method, such as the Bry–Boschan method [47], is widely used to identify
the peaks and troughs in the time series cycle. However, the turning point obtained by this method
needs to satisfy certain rules. The durations of the cycle and its expansion and contraction phases must
all exceed the minimum values set in advance. In order to avoid artificially set interference, this paper
chose the Markov regime switching (MRS) model proposed by Hamilton [48]—in which the turning
point is endogenously determined—to identify the fluctuation characteristics of the financial cycle.
Suppose there are two possible states of boom and depression represented by the regime variable,
where st . st = 1 means boom, and st = 2 means depression. In the MRS model, the probability that
the t-th period is in a certain regime j depends on the state i during the previous period. Although
these probabilities can be set to be time-varying, Markov switching models are generally specified
with constant probabilities [49]. The transition probability pij from regime i in period t − 1 to regime j
in period t can be expressed as
P(st = j st−1 = i) = pij , (8)
where pij ∈ (0, 1), i, j = 1 or 2. We can list these probabilities in a transition matrix as follows:
" #
p11 p12
P= . (9)
p21 p22
It is easy to see that there should be p11 + p12 = 1 and p21 + p22 = 1. Typically, we parameterize
these probabilities in terms of a logit,
p11 (δ11 ) = exp(δ11 )/[exp(δ11 ) + 1] and p21 (δ21 ) = exp(δ21 )/[exp(δ21 ) + 1], (10)
where δij are parameters that determine the regime probabilities with the identifying normalizations
δ12 = 0 and δ22 = 0. Then, the following MRS model with mean values µ(st ) varying with different
regimes is constructed:
FCIt = µ(st ) + εt , (11)
where εt ∼ N (0, σ). The model (11) is estimated by using the switching regression algorithm in Eviews
10.0 software, and the filtered estimates of the regime probabilities P(st = 1 =t ) and P(st = 2 =t ) can
also be calculated. Here, =t is the information set in period, t.
Next, the following indicators are defined for China and the United States, respectively:
i f P(st = 1 =t ) > 0.5

(
1,
ρt = . (12)
0, i f P(st = 1 =t ) ≤ 0.5
Finally, referring to Harding and Pagan’s method [50,51], a synergy index (SI) is constructed to
examine the comovement between the financial cycles of the two countries. The difference is that this
paper calculates the rolling form of the T period, where the value of T refers to the summation result of
the average duration of each regime estimated by the MRS model, i.e., the average duration of the
entire cycle. The specific calculation method of the consistency index is as follows:
Xk = t
SIt = [ρchn
k
×ρusa
k
+ (1 − ρchn
k
) × (1 − ρusa
k
)]/T. (13)
k=t−T +1
It can be seen that the index SIt calculates the proportion of time in which the financial cycles
of the two countries are in the same stage (prosperous or depressed) in a complete cycle. Therefore,
this paper uses SI to measure the synergy between the financial cycles of China and the United States.
Obviously, SI is greater than 0 and less than 1. The closer SI is to 1, the stronger the synchronization of
the two cycles.
3.3.3. Analytical Method of Transmission Paths

In theory, financial fundamentals, bilateral trade, and spillover effects of macroeconomic policies
can all cause changes in a country’s financial cycle [20,24,31,37]. In order to identify the impact of these
factors on the financial cycle synergy between China and the United States, we select and deal with the
various influencing factors as follows.
The financial indicators used in the calculation of the FCI in China and the United States already
cover the description of financial fundamentals and monetary policy. However, the factor of bank
credit loan (CL) was not considered when analyzing risk transmission. First, this is the result of the
variable selection based on empirical results when modeling. We did not remove it at the beginning,
but its load in each factor is not large in the factor analysis, and its coefficient is also not significant in
regression analysis with other factors. Second, we consider that the fluctuation of bank credit loan is an
influencing factor of internal financial fluctuations, but it is not a channel for risk transmission between
the two countries. For example, the US financial crisis may be related to its own credit expansion,
which is one of the reasons for the fluctuation of the US financial market, but the transmission of
US financial risks to other countries depends on other paths, such as trade, stock and other asset
markets, exchange rates, etc. Considering the limited impact of the domestic credit loan scale on
the international market, it should be excluded. Therefore, we calculate the fixed T-period rolling
correlation coefficient between the remaining five financial indicators to measure the synergy between
the real estate market, stock market, and foreign exchange market, as well as the coordination of
monetary policy in the two countries. Noting that the variables for calculating the correlation coefficient
need to satisfy the law of large numbers, the stability test will be first performed on each gap sequence
in the empirical part. In addition, the T-period moving average growth rate of bilateral trade between
China and the United States (expressed by TR) is selected as a proxy indicator for describing trade
links. Correspondingly, in this part of the analysis, the dependent variable also selects the T-phase
smooth correlation coefficient of the FCIs of the two countries.
Using Yitchn and Yitusa to represent the relevant sequences of China and the United States used in
this paper, respectively, the calculation formula of the T-phase rolling correlation coefficient rit of both
countries is as follows:
r
Pk=t chn chn usa usa Pk=t chn − Ychn 2 Pk=t usa 2
usa − Y ) ,
rit = k=t−T +1 [(Yik − Yit )(Yik − Yit )]/ k=t−T +1 (Yik it ) · k=t−T +1 (Yik it (14)
chn chn /T, Yusa =

where Yit = tk=t−T+1 Yik
P Pt usa 0
it k=t−T +1 Yik /T and i = (MS, IR, ER, SP, HP, FCI ) .
Considering the strong collinearity between independent variables rit , i = (MS, IR, ER, SP, HP, TR)0 ,
this paper will extract several common factors with obvious economic significance based on factor
analysis. Suppose there are m common factors, denoted by fi , i = 1, 2, . . . , m, then the factor model of
a single variable can be expressed as
rit = li1 f1t + li2 f2t + · · · + lim fmt + υit , (15)
where υi represents a special factor, which contains a random error, and is only related to the i-th
variable, lij is called the load of the i-th variable on the j-th factor, and the matrix L, which is composed
of it, is called the factor load matrix. This can be expressed in matrix form as follows:
Rt = LFt + υt , (16)
where Rt = (rMSt , rIRt , rERt , rSPt , rHPt , rTRt )0 , Ft = ( f1t , f2t , · · · , fmt )0 and υt = (υMSt , υIRt , υERt , υSPt , υHPt , υTRt )0 .
In order to make the practical meaning of the factor clearer, it is often necessary to orthogonally
rotate the load matrix L. Suppose there is an m-dimensional orthogonal matrix H, so that
L∗ = LH. (17)
In this paper, the maximum variance rotation method is used to obtain L∗ , and then the regression
method is used to obtain the estimations of common factors.
F̂t = L∗ 0 Ψ−1 Rt , (18)
where Ψ is the sample correlation matrix.

At the same time, there may be differences in the financial risk transmission paths and transmission
effects between China and the United States under different financial cycle synergy levels. Hence,
a threshold regression model [52] will be established to test and analyze the transmission paths of
financial cooperation between China and the United States. Taking two thresholds as an example,
the two thresholds are represented by V1 and V2 , and V1 < V2 . Then, the model can be constructed
as follows
rFCIt = β1 F̂t I (SIt ≤ V1 ) + β2 F̂t I (V1 < SIt ≤ V2 ) + β3 F̂t I (SIt > V2 ) + ut , (19)
where I (·) is an indicative function. When an event in parentheses occurs, its value is 1.
4. Results
4.1. The Calculation Results of the FCI

The SVAR model requires its endogenous variables to be stationary, so a unit root test is required.
This paper chose to use the augmented Dickey–Fuller (ADF) test. Table 2 illustrates the results, which
show that all gap sequences are stable at a 1% significance level.
Table 2. Unit root test results (augmented Dickey–Fuller (ADF), at level, without constant and trend).
Null Hypothesis: The Variable Has a Unit Root

CHN Gap1 Gap2 Gap3 Gap4 Gap5 Gap6 Gap7
t-Statistic −5.059 −6.3863 −5.4367 −5.7069 −5.6728 −5.8105 −5.1236
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 0.000
*** *** *** *** *** *** ***
USA Gap1 Gap2 Gap3 Gap4 Gap5 Gap6 Gap7
t-Statistic −6.0888 −4.1086 −4.437 −5.4806 −5.9417 −5.0096 −8.708
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 0.000
*** *** *** *** *** *** ***
Notes: (*) Significant at the 10% level, (**) significant at the 5% level, (***) significant at the 1% level, and (no) not
significant; lag length based on the Schwarz information criterion (SIC); probability based on MacKinnon (1996)
one-sided p-values.
The maximum lag order of the SVAR model is determined based on five criteria: likelihood ratio
(LR), final prediction error (FPE), Akaike information criterion (AIC), Schwarz information criterion
(SIC), and Hannan–Quinn information criterion (HQ). The result of determining the lag order is shown
in Table 3. For both countries, the optimal lag order for more than half of the criteria is 5, so the
order of the SVAR model is determined to be 5. Referring to the graphs of the inverse roots of the
AR characteristic polynomial, both SVAR models are stable. For the sake of simplicity of the article,
no specific figures are given.
Table 3. The lag order selections of the structural vector autoregressive (SVAR) model.
Lag LR FPE AIC SIC HQ

1 NA 4.64 × 10−11 −3.929127 −3.27608 −3.666891
2 3707.907 3.42 × 10−17 −18.05018 −16.74408 −17.52571
3 2299.024 4.81 × 10−21 −26.92024 −24.9611 −26.13354
CHN
4 1227.039 4.36 × 10−23 −31.62769 −29.01550 * −30.57875
5 174.9147 2.99 × 10−23 * −32.00904 * −28.74381 −30.69787 *
6 68.05228 * 3.21 × 10−23 −31.94456 −28.02627 −30.37114
1 NA 3.14 × 10−11 −4.318835 −3.665788 −4.0566
2 3091.233 2.58 × 10−16 −16.031 −14.72491 −15.50653
3 2001.172 1.2 × 10−19 −23.70487 −21.74573 −22.91817
USA
4 1165.584 1.4 × 10−21 −28.15837 −25.54618 −27.10943
5 296.2981 5.73 × 10−22 * −29.05625 * −25.79102 * −27.74508 *
6 66.36510 * 6.2 × 10−22 −28.98436 −25.06608 −27.41095
Note: (*) indicates lag order selected by the criterion (each test at 5% level).
Sustainability 2019, 11, x FOR PEER REVIEW 13 of 23

For the two identifiable long-term constraint matrices of Equation (6), the estimation results of
their parameters
calculated are shown
according in Table
to Equation (7)4.are
Based
shownon this, the structural
in Table 5. Finally,decomposition
Figure 2 shows method in index
the FCI pulse
analysis is further
calculation selected
results for the twoto countries.
calculate the cumulative impact of unit shock of each financial gap
sequence on inflation for 60 months. The results are shown in Figure 1. Next, the weight results
calculated accordingTableto Equation (7) are
4. Estimation shown
results in Tablematrix
of constraint 5. Finally,
F in SVARFigure 2 shows the FCI index
models.
calculation results for the two countries.
Estimated F_CHN Matrix:
−1.311 0.000 results
Table 4. Estimation 0.000of constraint
1.140 matrix
0.000F in 0.000 0.000
SVAR models.
−0.862 2.194 0.000 0.000 0.000 0.000 0.000
Estimated F_CHN Matrix:
−3.331 0.412 0.528 0.000 0.000 0.000 0.000
−1.311
0.000 0.000
0.566 0.000
1.713 1.140 0.000
0.215 * 0.000 0.000
0.000 0.000
0.000
−0.862 2.194 0.000 0.000 0.000 0.000 0.000
0.835 −0.320 −0.603 −0.571 1.038 −0.021 * 0.000
−3.331 0.412 0.528 0.000 0.000 0.000 0.000
−0.690 0.566
0.000 −0.384 1.713 −0.781 0.2150.483
* 0.000
0.000 0.935
0.000 0.000 0.000
−0.255 −0.320
0.835 0.438 −0.6030.281 −0.571
−0.486 0.411
1.038 −0.229
−0.021 * 0.670
0.000
−0.690
Estimated −0.384
F_USA −0.781
Matrix: 0.483 0.000 0.935 0.000
−0.255
1.483 0.438
0.000 0.281
0.000 −0.486 0.411
0.000 0.000 −0.229
0.000 0.670
0.000
0.657 F_USA
Estimated 2.056 Matrix:
0.000 0.000 0.000 0.000 0.000
0.956
1.483 −0.830
0.000 1.597
0.000 0.000
0.000 0.000
0.000 0.000
0.000 0.000
0.000
0.657
−0.417 2.056−0.467 0.000 0.875 0.000 0.000
1.676 0.000 0.000 0.000
0.000 0.000
0.956
−0.764 −0.830
−0.713 1.597
0.293 0.000 0.000
0.277 1.003 0.000
0.705 0.000
0.000
−0.417 −0.467 0.875 1.676 0.000 0.000 0.000
1.289
−0.764
0.496
−0.713
0.149
0.293
−0.749
0.277
0.000
1.003
0.976
0.705
0.000
0.000
−0.360 0.496
1.289 −0.280 0.149 −0.130 −0.749
0.050 * 0.181
0.000 −0.017 0.976* 0.570
0.000
Notes: The i-th −0.360
row and j-th −0.280
column−0.130
values in 0.050 *
the table 0.181
represent −0.017
the *
estimated 0.570
values of the i-th
row and
Notes: j-th
The i-thcolumn
row andelements of the
j-th column matrix.
values in the(*)table
indicates thatthe
represent the coefficient
estimated is not
values significant
of the i-th row at
andthe 5%
j-th
column
level. elements of the matrix. (*) indicates that the coefficient is not significant at the 5% level.
1.2 1.00
0.75
0.8
0.50
0.4
0.25
0.0 0.00
-0.25
-0.4
-0.50
-0.8
-0.75
-1.2 -1.00
5 10 15 20 25 30 35 40 45 50 55 60 5 10 15 20 25 30 35 40 45 50 55 60
Shock1 Shock2 Shock3 Shock1 Shock2 Shock3

Shock4 Shock5 Shock6 Shock4 Shock5 Shock6
(a) (b)
Figure 1.
1. (a) Accumulated
Accumulated response of GAP7_CHN to innovations; (b) Accumulated response of
GAP7_USA to innovations.
Table 5. Weights of financial indicators calculated based on SVAR model.

Table 5. Weights of financial indicators calculated based on SVAR model.
MS MS IRIR CL
CL ER ER SP SP HP HP
Weights w1 w 1
Weights w2w 2 ww33 w 4 w4 w 5 w5 w 6 w6
CHN 0.0048 0.1561 0.1641 0.2588 0.2296 0.1865
CHN 0.0048 0.1561 0.1641 0.2588 0.2296 0.1865
USA 0.3527 0.2491 0.0843 0.0391 0.1932 0.0816
USA 0.3527 0.2491 0.0843 0.0391 0.1932 0.0816
Sustainability 2019, 11, x FOR PEER REVIEW 14 of 23
2
FCI_CHN
FCI_USA
-1
-2
-3
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Figure 2. Calculation
Calculation results of financial conditions index (FCI) in China and the United States.
It can be be seen
seen from
fromFigure
Figure22that thatfromfrom1996 1996toto1997, 1997,thethefinancial
financial situation
situation in in
ChinaChina continued
continued to
deteriorate
to deteriorate duedue to insufficient
to insufficient domestic effective
domestic demand
effective and Asian
demand andfinancial turmoil. To
Asian financial stimulate
turmoil. To
demand
stimulateand demand ease deflationary
and ease deflationarypressures,pressures,
China implementedChina implementeda series ofa expansionary
series of expansionary financial
regulatory policies and
financial regulatory reform
policies and measures. The FCI began
reform measures. The FCI to pick
began uptogradually
pick up in 1998. However,
gradually in 1998.
with the gradual
However, with the decline
gradualof active
decline fiscal and monetary
of active fiscal and policies,
monetary FCI began
policies, to fall
FCIback
began to to
thefall
vicinity
back ofto
the zero
vicinitylineofsincethe 2000.
zero line From the2000.
since second From halfthe
of 2001
second until
halftheofsplit-share
2001 until structure reformstructure
the split-share in 2003,
China’s
reform in stock
2003,market
China’s continued
stock market to becontinued
sluggish, corporate
to be sluggish, financing was difficult,
corporate financingthe wasFCI value was
difficult, the
always
FCI value lesswasthanalways
zero, and lessthethan financial
zero, and situation was tight.
the financial Since the
situation wassecond half ofthe
tight. Since 2003,
secondbankhalf
credit
of
has
2003,increased,
bank credit andhasChina has experienced
increased, and Chinaahas partial overheating
experienced of theoverheating
a partial economy and rising
of the prices,
economy
resulting
and risinginprices,
a looseresulting
financial in environment.
a loose financial In order to prevent potential
environment. In order to risks in thepotential
prevent financial riskssystem,in
China adopted
the financial a number
system, Chinaof macro-control
adopted a number measures aimed at controlling
of macro-control measuresthe overheating of investment.
aimed at controlling the
With the increase
overheating in policy regulation
of investment. in 2005, China’s
With the increase in policy financial
regulation situation
in 2005, tightened,
China’s and this continued
financial situation
until the end
tightened, and of this
2006.continued
In 2007, due untilto the
the stimulation
end of 2006.ofIn the2007,
2008due Olympic
to theGames,
stimulationChina’s of economy
the 2008
improved,
Olympic Games, and theChina’s
stock market
economy wasimproved,
booming. and China’s FCI rose
the stock rapidly
market wasand reachedChina’s
booming. its peak. FCIAtrose
the
end of 2007, the US financial crisis affected China, and China’s
rapidly and reached its peak. At the end of 2007, the US financial crisis affected China, and China’sFCI fell rapidly. It reached its lowest
point
FCI fell at rapidly.
the end of 2008, and
It reached itsthe rate point
lowest and the extent
at the endofofdecline
2008, and were theunprecedented.
rate and the extent In response
of decline to
the
were financial crisis, China
unprecedented. implemented
In response to thetimely
financial regulation and launched
crisis, China implemented a package
timelyofregulation
expansionary and
policies,
launchedknown a package as theof“four trillion plan”.
expansionary In 2009,
policies, known the FCI rebounded
as the rapidly.
“four trillion plan”. In 2009, the FCI
Unfortunately,
rebounded rapidly. the European debt crisis followed in 2010. China’s financial situation fell sharply
again. In 2012, China’s
Unfortunately, the economic
European growth debt crisis fell below
followed 8% for the first
in 2010. time infinancial
China’s 14 years.situationSince then,fell
China
sharplyentered
again. aInnew 2012, period
China’s of medium
economicand low economic
growth fell below growth.8% for the Taking this as
first time inan14 opportunity,
years. Since
the
then,Chinese
China government
entered a new accelerated
period of andmedium
intensified andfinancial
low economicreform. growth.
One of the Takingmainthis measures
as an
taken was that Wenzhou, Shenzhen, and other places have been
opportunity, the Chinese government accelerated and intensified financial reform. One of the main set up as financial comprehensive
reform
measures pilottakenzones.wasThisthat “bottom-up”
Wenzhou, Shenzhen, reform mode and further
other placesstraightens
have beenthe financial
set up as jurisdiction
financial
of the central and
comprehensive localpilot
reform governments,
zones. Thiseffectively
“bottom-up” alleviating
reform the mode financing
further difficulties
straightens of thesmall and
financial
medium-sized
jurisdiction of enterprises,
the central and improves the economic
local governments, capacityalleviating
effectively of financialthe service entities.
financing In addition,
difficulties of
the accelerated
small speed of the enterprises,
and medium-sized marketizationand of interest
improves ratestheandeconomic
exchange capacity
rates has further
of financialstrengthened
service
the fundamental
entities. In addition, roletheof the market in
accelerated speedthe allocation of financialofresources.
of the marketization interest rates Therefore,
and exchangeChina’srates FCI
temporarily improved in 2012.
has further strengthened However, due
the fundamental to of
role thethe global
marketeconomic
in the downturn
allocation of and internalresources.
financial economic
structural
Therefore,problems,
China’s the FCIFCI began to decline
temporarily improved again in in 2013
2012.and went intodue
However, depression
to the inglobalthe latter half of
economic
the year until the first half of 2015. With the gradual recovery
downturn and internal economic structural problems, the FCI began to decline again in 2013 and of the economy, China’s macroeconomic
regulation and controlinreturned
went into depression the latter to half
“stable”,
of therather
year untilthan “positive”,
the first half and of started
2015. With a new theround
gradual of
financial
recovery reform. After 2015,China’s
of the economy, the FCImacroeconomic
fell back to a moderately regulationtight andrange
control of fluctuations.
returned to It can be
“stable”,
seen
ratherthatthan the Chinese FCI
“positive”, and measured
started a new in thisroundpaper is a goodreform.
of financial description of thethe
After 2015, changes
FCI fellinback China’s
to a
financial
moderately environment,
tight range and can be a useful
of fluctuations. It canbasis for analyzing
be seen China’s FCI
that the Chinese macroeconomic
measured inand thisfinancial
paper is
wave
a good dynamics.
description of the changes in China’s financial environment, and can be a useful basis for
Compared
analyzing China’s with the changes inand
macroeconomic the FCI and the
financial wave financial
dynamics.situation in the United States, in the first
half of 1996, the US
Compared withbanking
the changes industry wasFCI
in the in serious
and thecrisis and the
financial FCI continued
situation to decline.
in the United States, With
in the
launch
first half of of
a series
1996, of theinitiatives
US banking suchindustry
as raisingwas credit card issuance
in serious standards,
crisis and the FCI credit qualityto
continued improved
decline.
With the launch of a series of initiatives such as raising credit card issuance standards, credit
quality improved and the FCI began to pick up in early 1997. In the same year, the Asian financial
and the FCI began to pick up in early 1997. In the same year, the Asian financial crisis broke out and
spread rapidly, leading to the chaos of global financial markets, combined with the bursting of the IT
bubble in 2000 and the impact of the “911” incident, all of which contributed to a persistent sluggish
financial situation in the United States. Its FCI declined from the end of 1998 and remained in a tight
state until the second half of 2001. In order to restore the economy, the Federal Reserve cut interest
rates 13 times between January 2001 and June 2003, and achieved the lowest interest rate since 1958,
making the US financial market unprecedentedly active and causing large amounts of funds to flow
into the real estate market. However, there was no interest rate cutback for quite a long time afterwards,
which created a hidden danger for the financial crisis.
In 2007, the sub-loan crisis broke out in the United States, from the credit crisis to the Wall Street
financial crisis, and then triggered severe shocks in major stock markets around the world. The FCI
in the United States continued to decline. In response, the United States successively passed the
“A package of economic stimulus bills” with a total tax reduction of 168 billion dollars, launched
the “Emergency Economic Stability Act of 2008” with a 700 billion non-performing asset rescue plan,
and implemented the “Recovery and Reinvestment Act of the United States” with an increase of
787 billion dollars in fiscal expenditure. Through a series of economic stimulus plans, the financial
situation began to return to moderately loose range fluctuations in 2010. Subsequently, the United
States was also affected by the European debt crisis and the deterioration of the global economic
situation, and the financial state also experienced a long downturn. With the recovery of the US
economy, the financial situation returned to a moderate overall good trend in 2013. Therefore, it can
be seen that the changes in the US FCI are also consistent with the volatility reality of the overall
financial situation. Reasonable FCI calculations in China and the United States ensure the reliability of
subsequent analysis.
4.2. Comovement of China–US Financial Cycle

This section first uses the MS model to identify the financial cycles of China and the United
States based on the FCI calculated previously, and then calculates the consistency index according to
Equations (12) and (13). Table 6 shows the results of the stage division of financial cycle fluctuations.
From the results of the estimated mean of the two regimes, it can be seen that the two states of boom and
depression are well-identified by the model. Moreover, for both countries, the maintenance probability
of both states is high, showing a more stable feature. Further comparing the durations of the different
stages of the two financial cycles, we can find that the financial cycle fluctuations of China and the
United States both have significant asymmetry characteristics. The average length of prosperity and
depression in China’s financial cycle is 28.4 and 12.7 months respectively, which is characterized by the
asymmetry of “long prosperity and short depression”; while the average length of the corresponding
two states in the United States is 13.3 and 25.1 months, which is characterized by the asymmetry of
“long depression and short prosperity”. In addition, China’s financial cycle is about 41 months, and is
about 38 months for the United States. These results are basically consistent with the conclusions of
the existing literatures [32,36,38–40].
Table 6. Money supply (MS) model estimation results of financial cycles in China and the United States.
Parameters CHN USA

Boom µ(st = 1) 0.2388 *** 0.5177 ***
Depression µ(st = 2) −0.4988 *** −0.2634 ***
p11 0.9648 0.9246
Regime maintenance probability
p22 0.9210 0.9602
Expected duration of boom 28.3869 13.2700
Expected duration of depression 12.6594 25.1413
Note: (***) Significant at the 1% level.
investment. The financial cycle comovement between the two countries fluctuated at a low level
between 2000 and 2002, and even decoupling occurred. As China joins the World Trade
Organization and integrates into the global economy, the dependence between China and the
United States on commodity markets and financial markets has also deepened. During the US
financial crisis
Sustainability in 4151
2019, 11, 2009, the synergy between the financial cycles of the two countries rose sharply 15 of 22
and reached a maximum due to the homogeneity of policies. After the crisis broke out, China’s
exports to the United States fell sharply. The financial crisis intensified the prominence of the
Further
severity of calculating
the Dollar the filtered
Trap, whichregime probabilities
prompted of the FCIgovernment
the Chinese (see Figure 3 to
for diversify
the results)itsidentifies
foreign
two states of the financial cycle. The result of the synergy index calculated by
exchange reserves to gradually eliminate its dependence on the US financial market. Therefore, Equation (13) is finally
the
obtained.
synchronicity Sinceofathe
complete
financialfinancial
cycles of cycle
the in thecountries
two United States is 38 months
in 2009–2011 (less than
was basically in41anmonths
irrelevantin
China), the results of the 38-phase rolling synergy index are calculated by
state. After 2012, as the US economy recovered and the Chinese economy entered a period of Equation (13). The results
are given in
moderate Figureadjustment,
growth 4, which also andshows the 38-phase
the synergy between rolling correlation
the financial coefficient
cycles of the two of countries
the two FCIswas
calculated according to
basically maintained at Equation (14) asofa around
a stable period reference.
0.6.
Boom Boom
1.0 1.0
0.8 0.8
0.6 0.6
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Sustainability 0.0 17 of 23
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(a) filtered regime probabilities. (a) FCI of China;
Figure 3. Markov switching (b) (b) FCI of the United
States.
Figure 3. Markov switching filtered regime probabilities. (a) FCI of China; (b) FCI of the United States.
Figure
Figure 4. The
4. The synergy
synergy indexand
index andcorrelation
correlation coefficient
coefficientofofthe financial
the cycles.
financial cycles.
Figure 4 shows that the synergy of the financial cycles between China and the United States
In summary,
has the synergy
obvious time-varying of the financial
characteristics. volatility
Since between
the mid-1990s, China
China andand the United
the United StatesStates
have has
changed significantly
continued intheir
to develop recent years. Especially
economies, during
and their trade the two
relations financialand
and financial crises, the financial
economic exchangescycle
synergy of the two countries was significantly higher than other periods. On the one hand, this
illustrates the existence of financial risk contagion effects among countries. On the other hand, it can
also reflect the strengthening of coordination and cooperation among countries in policy control
when faced with risks. In addition, the comovement of financial volatility between China and the
United States has both high levels of cooperation in response to crises and abandonment of each
have entered a period of rapid development. The synergy of the financial cycle has risen remarkably.
Especially during the period of Asian financial turmoil, the financial cycles of the two countries
experienced a high degree of synergy. As China–US economic relations became increasingly close,
the imbalance in economic relations between the two countries gradually intensified. Not only did the
imbalance between the huge trade deficit of the United States and the huge surplus of China occur,
but it also showed an imbalance between the investment of the United States in China, mainly in stock
investment, and that of China in the United States, mainly in bond investment. The financial cycle
comovement between the two countries fluctuated at a low level between 2000 and 2002, and even
decoupling occurred. As China joins the World Trade Organization and integrates into the global
economy, the dependence between China and the United States on commodity markets and financial
markets has also deepened. During the US financial crisis in 2009, the synergy between the financial
cycles of the two countries rose sharply and reached a maximum due to the homogeneity of policies.
After the crisis broke out, China’s exports to the United States fell sharply. The financial crisis
intensified the prominence of the severity of the Dollar Trap, which prompted the Chinese government
to diversify its foreign exchange reserves to gradually eliminate its dependence on the US financial
market. Therefore, the synchronicity of the financial cycles of the two countries in 2009–2011 was
basically in an irrelevant state. After 2012, as the US economy recovered and the Chinese economy
entered a period of moderate growth adjustment, and the synergy between the financial cycles of the
two countries was basically maintained at a stable period of around 0.6.
In summary, the synergy of the financial volatility between China and the United States has
changed significantly in recent years. Especially during the two financial crises, the financial cycle
synergy of the two countries was significantly higher than other periods. On the one hand, this illustrates
the existence of financial risk contagion effects among countries. On the other hand, it can also reflect
the strengthening of coordination and cooperation among countries in policy control when faced with
risks. In addition, the comovement of financial volatility between China and the United States has
both high levels of cooperation in response to crises and abandonment of each other in the game
of their respective interests. Therefore, this time-varying nonlinear feature should be considered
when analyzing the coordination or risk conduction path. In other words, the factors affecting the
financial cycle synergy between China and the United States may differ during different periods,
and the mechanisms and driving forces for financial risks to spread between the two countries may
also undergo important changes.
5. Discussion on Transmission Paths

This section will discuss the conduction paths of the financial cycles of the two countries.
Specifically, the potential common factors are first refined, and then a threshold regression model is
established to analyze the conduction paths under different levels of synergy.
According to Equation (16), factor analysis is carried out on six indicators that represent the
correlation between trade, asset market, and policy in the two countries. According to the criterion that
the eigenvalue is greater than 1, the number of selected factors is m = 4, and the estimated result of the
load matrix L is shown in Table 7. Furthermore, the load matrix is orthogonally rotated according to
the principle of variance maximization, and the result of the rotated load matrix L* is also shown in
Table 7. It can be seen from the results that the cumulative contribution rate of the four common factors
for the variance of the original variables is 1, indicating that the six variables are perfectly reduced to
four dimensions by factor analysis.
According to the rotational load of each common factor, rMS —which represents the trade correlation
between the two countries—has the largest load on the common factor f1 ; hence, f1 is called the trade
factor. The correlations between stock prices and between house prices in both countries have higher
loads on factor f2 , so f2 is defined as an asset factor. According to the same principle, factor f3 and
factor f4 are defined as the exchange rate factor and the interest rate factor, respectively.
Sustainability 2019, 11, x FOR PEER

TableREVIEW
7. Load matrix estimation results in factor analysis. 18 of 23
Loadings L ratio
Unrotatedcontribution
Cumulative f1
0.5002 f2
0.7470 f3
0.9116 f4
1.0000
RotatedrLoadings:
MS L* 0.7727f1 f2
−0.0025 f3
0.2997 f4
−0.0722
rIR
rMS 0.0437
0.7986 −0.3135
0.0000 0.1454
0.2323 0.3777
−0.0209
rER −0.0837 0.2358 0.5316 −0.0859
rIR 0.0849 −0.1913 −0.0307 0.4682
rSP 0.2974 0.5680 −0.2279 0.0058
r
rHPER −0.0465
−0.0802 0.0355 0.0743
0.4656 0.5909 −0.0082
0.3058
rSP
rTR 0.2074
0.8543 0.6118 −0.1401
−0.1126 −0.0447 −0.2091
0.0642
r
ContributionHP
ratio −0.1272
0.5002 0.4883
0.2468 0.1828
0.1646 0.1851
0.0884
r TR
Cumulative contribution ratio 0.8387
0.5002 0.0700
0.7470 −0.2392
0.9116 0.0243
1.0000
Rotated Loadings: L* f1 f2 f3 f4
According to the rotational load of each common factor, rMS —which represents the trade
rMS 0.7986 0.0000 0.2323 −0.0209
correlation between the tworIRcountries—has the0.0849
largest load on the−0.0307
−0.1913 common factor
0.4682 f 1 ; hence, f 1
r
is called the trade factor. The −0.0465 0.0355 0.5909 −0.0082
ER correlations between stock prices and between house prices in both
countries have higher loadsrSPon factor f 2 , so 0.2074 0.6118 −0.0447 −0.2091
f 2 is defined as an asset factor. According to the
rHP −0.1272 0.4883 0.1828 0.1851
same principle, factor f 3 and rTR factor f 4 are 0.8387
defined as0.0700
the exchange rate factor
−0.2392 0.0243 and the interest
rate factor, respectively.
In addition,
In addition, r rMS ,, which
which indicates
indicates the
the correlation
correlation of
of the
the supply
supply of
of the
the national
national currency,
currency, has
has aa
MS
load of
load of up
uptoto0.7986
0.7986factor
factorf1 ,fbut
1
, but
thethe issuance
issuance of money
of money in the
in the external
external economy
economy is more
is more useful
useful for
balancing trade balances and stable exchange rates, so the definition of the factor
for balancing trade balances and stable exchange rates, so the definition of the factor name is not name is not used.
Its loadIts
used. onload
the exchange rate factor
on the exchange ratef3 factor
also reaches 0.2323,
f 3 also while0.2323,
reaches the load on the
while theother
loadtwo on factors is very
the other two
small. These results also prove the rationality of such treatment. After obtaining a stable
factors is very small. These results also prove the rationality of such treatment. After obtaining a factor rotation
result,
stable the factor
factor scoreresult,
rotation sequences can bescore
the factor calculated according
sequences can betocalculated
Equation according
(18) for characterizing the
to Equation (18)
fluctuation of each common factor. This paper selected the regression method to
for characterizing the fluctuation of each common factor. This paper selected the regression method predict these four
common
to predictfactors, and common
these four the results are shown
factors, in Figure
and the results5.are shown in Figure 5.
2.0 1.2
0.8
1.5
0.4
1.0
0.0
0.5 -0.4
0.0 -0.8
-1.2
-0.5
-1.6
-1.0
-2.0
-1.5 -2.4
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
(a) (b)
1.6
2.0
1.6 1.2
1.2
0.8
0.8
0.4 0.4
0.0 0.0
-0.4
-0.4
-0.8
-1.2 -0.8
-1.6
-1.2
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
(c) (d)
Figure 5.5. Score
Figure Scoresequences
sequencesof ofcommon
commonfactors:
factors:(a)
(a)trade
tradefactor
factorf 1f1;;(b)
(b)asset
assetfactor
factorf f22;; (c)
(c) exchange
exchange rate
rate
factor ff33; (d) interest rate factor f44..
factor
Finally, the four factors obtained are used as explanatory variables, and the threshold
regression analysis of the rolling correlation coefficient rFCIt is performed. The synergy index SI is
Finally, the four factors obtained are used as explanatory variables, and the threshold regression
analysis of the rolling correlation coefficient rFCIt is performed. The synergy index SI is chosen as
the threshold variable. The threshold test results of Table 8 show that there are two thresholds at the
significance level of 0.01 with values of 0.361 and 0.583.
Table 8. Multiple threshold tests.
Threshold Test 1 F-Statistic Scaled F-Statistic Critical Value 2

0 vs. 1 * 44.095 220.477 22.400
1 vs. 2 * 34.271 171.357 24.420
2 vs. 3 4.689 23.443 25.530
Threshold Values: 0.361, 0.583
Notes: Method: Bai–Perron tests of L + 1 vs. L sequentially determined,
1 2 Bai–Perron critical values, and (*)
significant at the 0.01 level.
According to the threshold regression results in Table 9, we can make an intuitive judgment
about the main factors affecting the synergy of financial cycles between China and the United States.
When the synergy is at a low level (i.e., less than 0.361), the growth of bilateral trade and the enhanced
correlation of exchange rates are the main reasons for the increase in the synergy of financial cycles
between China and the United States. With the improvement of the level of synergy, when it is at a
medium level (i.e., between 0.361 and 0.583), the linkages of trade growth, stock market, real estate
market, and interest rate policy between the two countries become important. When the level of
synergy reaches a high level (i.e., greater than 0.583), the linkage of trade, house price, stock price,
exchange rate, and interest rate can all cause the change in financial cycle synergy between the two
countries. However, two policy-related factors, such as the exchange rate and interest rate, have a
negative effect. Thus, under different levels of financial cycle synergy, the main factors that cause the
change in financial cycle synergy between China and the United States are obviously different.
Table 9. Threshold regression results.
Threshold Interval f 1 (Trade) f 2 (Asset) f 3 (Exchange Rate) f 4 (Interest Rate)

SI < 0.361 0.4690 * −0.1361 0.5251 * 0.0533
0.361 ≤ SI < 0.583 0.1032 * 0.2056 * 0.0073 0.1999 *
0.583 ≤ SI 0.1012 * 0.1816 * −0.1210 * −0.1409 *
R-squared 0.8464 Adjusted R-squared 0.8369
F-statistic 88.5767 Prob. (F-statistic) 0.0000
Note: (*) Significant at the 0.05 level.
The above results confirm that the strengthening of bilateral trade is the basis of the financial cycle
linkage because the coefficient of trade factor is significant at each threshold interval. Simultaneously,
it also implies that some important changes have taken place in the transmission channels of financial
risks, with the change of macroeconomic and financial market linkages between China and the
United States.
The financial link between the two countries is generally poor when the level of trade between the
two countries is low. In an open economy, a country’s net capital outflow is always equal to net exports.
When there is a trade surplus, capital flows out, and when there is a trade deficit, capital flows in.
The flow of capital between the two countries is basically dependent on the income and expenditure of
the goods trade. As the trade between the two countries continues to strengthen, the importance of the
foreign exchange market will first increase significantly, so the exchange rate channel becomes the main
mechanism for financial shock and risk transmission between the two economies. Due to the closer
relationship between the two countries with respect to economic and financial activities, the linkage of
asset prices—which is represented by stock prices and housing prices—has become the main driving
factor for the coordinated movement of the financial cycle. The capital market becomes the main
channel for the transmission of international financial risks. In addition, the interest rate factor also
shows a positive increase. On the one hand, this means that using foreign currency accumulated by
trade to purchase foreign bonds with interest has become an important means of financial linkage
between the two countries. On the other hand, it also implies that the two countries have not yet felt
an urgent need to coordinate the use of macro-control policies to cope with the global financial crisis or
economic recession. When the financial cycles of China and the United States showed a high degree of
synergy—mainly during the two financial crises—the financial market volatility of the two countries
was highly correlated. At this time, trade and asset factors were still the main means by which to link
the financial cycle. However, in order to cope with the impact of the financial crisis, the exchange rate
factors and interest rate factors which can represent the coordination of monetary policy—such as
money supply, exchange rate, and interest rate—have obviously decoupled the financial cycles of the
two countries.
6. Conclusions
This paper selects six financial indicators: money supply, interest rate, credit loans, exchange rate,
stock price, and house prices in China and the United States. By using the SVAR model and the
impulse response function to determine the weights of financial indicators, we synthesized the financial
conditions indices (FCIs) of the two countries. Combined with the actual financial situation of the two
countries, the two FCIs constructed in this paper can better reflect reality, so they offer a useful basis
for analyzing the fluctuation of the financial cycle in the two countries.
The results of the stage division of the financial situation index based on the MS model show
that the lengths of the financial period in China and the United States are 41 months and 38 months,
respectively. Another finding is that the financial cycle fluctuations of the two countries have distinct
asymmetry features. The US financial cycle is characterized by a period of “long depression and
short prosperity”, while China’s financial cycle is characterized by long prosperity and a short
depression”. Therefore, in the process of formulating and implementing macroeconomic regulation,
control policies, and financial reform policies, the Chinese government should control the intensity of
the implementation of expansionary policies to prevent excessive responses to the deterioration of the
financial situation.
Furthermore, this paper constructs and calculates the synergy index (SI) to measure the synergy
of the financial cycle between China and the United States. We found that the synergy of the financial
cycles of the two countries has changed significantly in the past two decades. Especially during the two
financial crises, the financial cycles in China and the United States showed a high degree of synergy.
This implies that we should pay attention to nonlinear problems in the regression analysis of the
subsequent impact paths.
In order to avoid the influence of the collinearity between variables on the estimation results in
the analysis of the conduction path of the financial cycle, the four common factors of trade, assets,
exchange rate, and interest rate are first compacted by using factor analysis. The results of the threshold
test show that there are two thresholds, i.e., 0.361 and 0.583, when the synergy index (SI) is used as the
threshold variable. Finally, the threshold regression results show that the trade factor is the basis of
the financial cycle synergy. When the synergy is at a low level (SI < 0.361), the exchange rate factor is
the main cause of the financial cycle comovement change, and also the main channel of international
financial risk. As the financial cycle synergy increases (0.361 ≤ SI < 0.583), the asset factor and interest
rate factor start to become the main reason for the changes in the financial cycle synergy. When the
level of synergy breaks through 0.583, the capital factor based on stock prices and house price is still
the main path of financial market linkage and risk transmission, but the linkage of monetary policy
between the two countries shows a restraining effect on synergy.
In summary, the policy implications for China include the following points: China should
strengthen the relevant monitoring of its own financial cycle and its major trading partners in order
to cope with external risks in a timely and correct manner. If the synergy of the financial cycle is
low, we should pay greater attention to the transmission of financial risks between foreign exchange
markets. When the financial cycle synergy of the two countries reaches a high level and the capital
market becomes the main transmission mechanism of financial risk, we should carefully observe the
fluctuation of domestic and foreign capital markets and establish a certain isolation mechanism to
control the further spread of financial risk. At the same time, we should focus on the coordinated use
of macroeconomic regulation and control policies, especially monetary policies, with other countries to
jointly resist the transmission impact of financial shocks on the real economy.
For the United States, the above recommendations are still applicable. However, considering
the importance of the United States in international financial markets, such as foreign exchange and
securities as well as in trade, the United States should give due consideration to the impact on other
countries’ financial and economic aspects while implementing its own regulatory policies. In addition,
attention should be paid to the fundamental role of trade in financial linkages.
Our study also suffers from some limitations. In this paper, the synchronicity index or the
rolling correlation coefficient is used to measure the financial synchronicity between China and the
United States, and it is used as an explanatory variable to analyze the transmission of financial risk.
This actually implies that the transmission of risk between China and the United States is symmetrical.
In reality, it is likely that the impact of China’s financial shock on US finance and the impact of US
financial shock on China’s finance are asymmetric. Therefore, asymmetry in the financial relationship
between China and the United States may be the direction of future research.
Author Contributions: Conceptualization, W.S. and P.S.; methodology, X.J.; formal analysis, X.J. and P.S.;
investigation, T.W. and P.S.; data curation, X.J.; writing—original draft preparation, X.J.; writing—review and
editing, T.W.; supervision, W.S.; project administration, P.S.; funding acquisition, P.S.
Funding: This research was funded by “Project of Philosophy and Social Sciences in Colleges and Universities of
Jiangsu Province, grant number 2016SJD790023” and “China Postdoctoral Science Foundation Funded Project,
grant number 2016M591947”.
Conflicts of Interest: The authors declare no conflict of interest.
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© 2019 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access
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The Synergy of Financial Volatility Between China

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sustainability

Sustainability 2019, 11, 4151; doi:10.3390/su11154151 www.mdpi.com/journal/sustainability

3. Indicators, Data, and Methods

3.1. Selection of Financial Indicators

3.2. Description and Processing of Data

Table 1. Symbolic description of financial gap sequences.

3.3.1. Construction Method of the FCI

Ayt = As0 + As0 yt−1 + · · · + Asp yt−p + But , (2)

and the reduced form error structure is given by

Aεt = But or εt = A−1 But = Sut ,

(I − A1 − A2 − · · · − Ap )−1 εt = Ψεt = Fut , (5)

3.3.2. Measurement Method of the Comovement

i f P(st = 1 =t ) > 0.5

3.3.3. Analytical Method of Transmission Paths

chn chn /T, Yusa =

rit = li1 f1t + li2 f2t + · · · + lim fmt + υit , (15)

F̂t = L∗ 0 Ψ−1 Rt , (18)

where Ψ is the sample correlation matrix.

4.1. The Calculation Results of the FCI

Null Hypothesis: The Variable Has a Unit Root

Lag LR FPE AIC SIC HQ

Sustainability 2019, 11, x FOR PEER REVIEW 13 of 23

Shock1 Shock2 Shock3 Shock1 Shock2 Shock3

Table 5. Weights of financial indicators calculated based on SVAR model.

4.2. Comovement of China–US Financial Cycle

Parameters CHN USA

0.0 2019, 11, x FOR PEER REVIEW

5. Discussion on Transmission Paths

Sustainability 2019, 11, x FOR PEER

Table 8. Multiple threshold tests.

Threshold Test 1 F-Statistic Scaled F-Statistic Critical Value 2

Table 9. Threshold regression results.

Threshold Interval f 1 (Trade) f 2 (Asset) f 3 (Exchange Rate) f 4 (Interest Rate)

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