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Forecasting Financial Stress Indices in Korea: A Factor Model Approach

Listed author(s):
  • Hyeongwoo Kim
  • Wen Shi
  • Hyun Hak Kim

We propose factor-based out-of-sample forecast models for Korea's financial stress index and its 4 sub-indices that are developed by the Bank of Korea. We extract latent common factors by employing the method of the principal components for a panel of 198 monthly frequency macroeconomic data after differencing them. We augment an autoregressive-type model of the financial stress index with estimated common factors to formulate out-of-sample forecasts of the index. Our models overall outperform both the stationary and the nonstationary benchmark models in forecasting the financial stress indices for up to 12-month forecast horizons. The first common factor that represents not only financial market but also real activity variables seems to play a dominantly important role in predicting the vulnerability in the financial markets in Korea.

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File URL: http://cla.auburn.edu/econwp/Archives/2016/2016-10.pdf
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Paper provided by Department of Economics, Auburn University in its series Auburn Economics Working Paper Series with number auwp2016-10.

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Date of creation: Sep 2016
Handle: RePEc:abn:wpaper:auwp2016-10
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