The Financial Stress Index: Identification of Systemic Risk Conditions
Summary
Financial stability is the ability to withstand shocks. Financial systemic risk is the potential for movement from one stable positive equilibrium to another stable negative equilibrium in response to financial stress.
Financial stress is an aggregate of brief and prolonged pressures or shocks applied to each element of the system over time.
Suggested indicator measures for FSIs: credit spreads, funding spreads, equity valuations, securitization, real estate, foreign exchange market.
This study applies different methods of indicator weighting, including: equal market weights, credit weights, portfolio theoretic weights, and principal component analysis weights, but emphasizes the superiority of dynamic principal component analysis over other methods.
Connects with: @illing2006
Annotations
oet2015 - p. 421
Financial conditions indices (FCIs) look at instances where prices and interest rates deviate from long-term trends
oet2015 - p. 421
It is important to note that an FCI is intended to indicate overall economic acceleration and deceleration.
oet2015 - p. 421
financial stress indices (FSIs) pursue the risk management objective of averting risk specifically in the financial system.
oet2015 - p. 421
we build upon existing literature to develop a measure of financial stress called the Cleveland Financial Stress Index (CFSI)
oet2015 - p. 421
Financial stability typically requires the ability to withstand shocks
oet2015 - p. 422
Systemic risk is more narrowly interested in “movement from one stable (positive) equilibrium to another stable (negative) equilibrium” ([30], p. 65).
oet2015 - p. 422
Systemic risk is then interested specifically in the potential for adverse reactions to stress while the study of financial stability considers the potential for stress to act as a cause of adverse and advantageous outcomes.
oet2015 - p. 422
stress which is the aggregate of brief pressure (shocks) and prolonged pressures applied to each element of the system over time.
oet2015 - p. 422
Illing and Liu define financial stress “as the force exerted on economic agents by uncertainty and changing expectations of loss in financial markets and institutions
oet2015 - p. 422
each indicator should provide insight into the nature of stress.
oet2015 - p. 422
indicators must be produced in a timely manner to facilitate concurrent measurement of stress
oet2015 - p. 422
the extent to which market variables deviate from some long-term trend should produce a meaningful historical comparison of stress severity
oet2015 - p. 422
When feasible, our measure of stress for the United States financial system—the Cleveland Financial Stress Index (CFSI)—uses daily observable financial-market data to capture the continuity of stress in financial markets.
oet2015 - p. 440
We consider candidate weighting methodologies that include equal market weights, credit weights, portfolio theoretic weights, and principal component analysis weights.
oet2015 - p. 440
dynamic principal component analysis may accommodate the adaptive nature of the financial system through non-constant weights and avoid the critique of arbitrary market selection suffered by credit weights
oet2015 - p. 443
- Illing, M.; Liu, Y. Measuring financial stress in a developed country: An application to Canada. J. Financ. Stab. 2006, 2, 243–265.
oet2015 - p. 443
- Gramlich, D.; Miller, G.; Oet, M.; Ong, S. Early Warning Systems for Systemic Banking Risk: Critical Review and Modeling Implications. Bank. Bank Syst. 2010, 5, 199–211.