Modeling the Costs of Trade Finance During the Financial Crisis of 2008-2009: An Application of Dynamic Hierarchical Linear Model

Abstract

The authors propose a dynamic hierarchical linear model (DHLM) to study the variations in the costs of trade finance over time and across countries in dynamic environments such as the global financial crisis of 2008-2009. The DHLM can cope with challenges that a dynamic environment entails: nonstationarity, cross-sectional heterogeneity and parameters changing over time. The authors employ a DHLM to examine how the effects of four macroeconomic indicators on trade finance costs varied across 8 countries over a period of five years from 2006 to 2010. They find GDP growth has a negative effect on trade finance costs that becomes more negative in the year of the crisis, while inflation has a positive effect on trade finance costs that becomes more pronounced during the crisis. They also find that trade intensity has a positive effect on the cost of trade finance, and this effect was magnified during the crisis. Finally, somewhat surprisingly, stock market capitalization has a positive effect on trade finance cost. The authors also note considerable country-specific heterogeneity in these effects, which underscore the need for a DHLM. The authors propose extensions to the model and discuss its alternative uses in different contexts.

Keywords: Trade Finance, Financial Crisis, Time Series Analysis, Bayesian Models

JEL Classification: C11, F30, F65, G01