A Robust Set of Indicators for the Financial Stress and Financial Stability: Taiwan¡¯s Case Studies

This study sets up a detective system for Taiwan¡¯s financial stability with two spindles of the market-based and the bank-based, and uses ¡°Two-state Markov regime-switching¡± method to capture the turning points from Taiwan¡¯s previous major financial crises through the volatility of Taiwan¡¯s financial stress index between 1997Q1 and 2014Q4. On this basis, a further study to propose the research of ¡°a robust set of indicators for the Taiwan¡¯s financial stability¡± uses ¡°noise to signal ratio¡± method from the candidate variables of bank-based Taiwan¡¯s financial stability, to filter out composite indicator of Taiwan¡¯s financial stability with early warning functions as a supervisory tool for financial stability, effectively to detect and alert Taiwan¡¯s financial crises. Empirical results proves, ¡°two-state Markov regime-switching¡± method with the market-based Taiwan¡¯s financial stress index (FSI), it sure can rationally determine the turning points for Taiwan¡¯s previous major financial crises and successfully identify Asian financial crisis, dot-com bubble, cross-strait political-economic tensions, global financial crisis (GFC), European debt crisis, etc., especially to capture the financial crisis triggered by cross-strait political and economic tensions in 2004Q2, which completely reveals an individual characteristic of political sensitive gene in Taiwan¡¯s financial system. Moreover, a composite indicator of Taiwan¡¯s financial stability (CITFS) constructed by bank-based measure has a good early warning capability to detect the events of Taiwan¡¯s previous major financial crises, and provide Taiwan¡¯s financial supervisory authority some important reference to build up the financial early warning mechanism.