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This paper studies the extent to which economic policy uncertainty shocks in major economies affect real economic activity in small open economies. We use Hong Kong as a case study. Following Baker, Bloom and Davis (2016), we construct a newspaper‐based economic policy uncertainty index for Hong Kong for the period 1998 to 2016. We estimate international spillovers of uncertainty and find large spillovers of uncertainty from major economies to Hong Kong. Furthermore, using a structural vector autoregressive approach, we show that a rise in domestic economic policy uncertainty leads to tight financial conditions, and lower investment and vacancy posting, dampening domestic output growth.

Standard macroeconomic models have difficulties accounting for the surge in international reserves of Asian countries in the aftermath of the Asian Financial Crisis of 1997. We propose precautionary demand for saving generated by model uncertainty as an important driver of this phenomenon. Using Korean data, we estimate a simple permanent income model augmented with model uncertainty, find a structural break at the point of the Asian Financial Crisis, and identify a rise in concern for model misspecification which is distinct from an increase in income volatility. The post-crisis concern for model misspecification implies a reasonable detection error probability. We also show that learning serves as an additional powerful amplification mechanism in our framework.

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We provide a theory-based inquiry into the contours of China's international balance sheets after the renminbi becomes convertible under the capital account. We construct a two-country general equilibrium model with trading in equities and bonds and calibrate the model with U.S. and Chinese data. We interpret Chinese capital account liberalization as a removal of restrictions that prohibit agents trading Chinese bonds and U.S. equities. We explore how international risk-sharing can be achieved through portfolio diversification in each of these asset market configurations. We also look at how these holdings would change as China gradually rebalanced its production with a larger share of labor income, and as the productivity gap between China and the United States narrowed. We find that both U.S. and Chinese residents would have incentives to increase their holdings in each other's equities and to issue debt in each other's currency.

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Market sentiments influence the dynamics of Hong Kong’s macro‐critical property market, but the unobservable nature of market sentiments makes it difficult to systemically assess this sentiment channel. Using text mining techniques, this paper sets up a news‐based property market sentiment index and a Google Trends‐based buyer incentive index for Hong Kong and studies the sentiment channel of transmission in the Hong Kong property market. The news‐based property market sentiment index can reflect the change in sentiments in past key events, with the sentiments in the primary market tending to lead that of the secondary market during the low housing supply period. For the Google Buyer Incentive Index, we find that it has value‐added in forecasting (or nowcasting) the official property price index. In mapping out the sentiment channel using a structural vector‐autoregressive model, we find that an improvement in market sentiments could stimulate buyers’ incentives, which then together would affect property prices and transaction volumes.

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