On the interaction between market and credit risk: a factor-augmented vector autoregressive (FAVAR) approach
AbstractThe aim of the paper is to understand the interaction between market and credit risk. Using a comprehensive set of Italian data, we apply a factor model to identify the common sources of risk driving fluctuations in the real and financial sectors. The common latent factors are then inserted in a VAR framework via a Factor Augmented Vector Autoregressive (FAVAR) approach to analyse the role of risk interactions with monetary policy shocks. We find that the impact of a restrictive monetary policy shock on credit risk is amplified when considering the feedback effect deriving from macroeconomic and equity market risk. Thus, neglecting dynamic interactions among risks may lead to biased estimates of the overall risk measure. The approach provides a framework for modelling macro and financial feedback dynamics, shedding some light on the complex interdependence between the financial sector and the real economy.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 779.
Date of creation: Oct 2010
Date of revision:
FAVAR approach; credit risk; market risk; factor model;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-11-20 (All new papers)
- NEP-BAN-2010-11-20 (Banking)
- NEP-MIC-2010-11-20 (Microeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ben Bernanke & Jean Boivin & Piotr S. Eliasz, 2005.
"Measuring the Effects of Monetary Policy: A Factor-augmented Vector Autoregressive (FAVAR) Approach,"
The Quarterly Journal of Economics,
MIT Press, vol. 120(1), pages 387-422, January.
- Tom Doan, . "RATS programs to replicate Bernanke, Boivin, Eliasz FAVAR paper," Statistical Software Components RTZ00012, Boston College Department of Economics.
- Ben S. Bernanke & Jean Boivin & Piotr Eliasz, 2004. "Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach," NBER Working Papers 10220, National Bureau of Economic Research, Inc.
- Ben S. Bernanke & Jean Boivin & Piotr Eliasz, 2004. "Measuring the effects of monetary policy: a factor-augmented vector autoregressive (FAVAR) approach," Finance and Economics Discussion Series 2004-03, Board of Governors of the Federal Reserve System (U.S.).
- James H. Stock & Mark W. Watson, 2005. "Implications of Dynamic Factor Models for VAR Analysis," NBER Working Papers 11467, National Bureau of Economic Research, Inc.
- Jushan Bai & Serena Ng, 2004.
"Evaluating Latent and Observed Factors in Macroeconomics and Financ,"
- Bai, Jushan & Ng, Serena, 2006. "Evaluating latent and observed factors in macroeconomics and finance," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 507-537.
- Stock, James H & Watson, Mark W, 2002. "Macroeconomic Forecasting Using Diffusion Indexes," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 147-62, April.
- Mönch, Emanuel, 2005.
"Forecasting the yield curve in a data-rich environment: a no-arbitrage factor-augmented VAR approach,"
Working Paper Series
0544, European Central Bank.
- Moench, Emanuel, 2008. "Forecasting the yield curve in a data-rich environment: A no-arbitrage factor-augmented VAR approach," Journal of Econometrics, Elsevier, vol. 146(1), pages 26-43, September.
- Lutz Kilian, 1998. "Small-Sample Confidence Intervals For Impulse Response Functions," The Review of Economics and Statistics, MIT Press, vol. 80(2), pages 218-230, May.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.