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A new index of financial conditions

  • Gary Koop
  • Dimitris Korobilis

We use factor augmented vector autoregressive models with time-varying coe¢ cients to construct a nancial conditions index. The time-variation in the parameters allows for the weights attached to each nancial variable in the index to evolve over time. Furthermore, we develop methods for dynamic model averaging or selection which allow the nancial variables entering into the FCI to change over time. We discuss why such extensions of the existing literature are important and show them to be so in an empirical application involving a wide range of nancial variables.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2013_06.

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Handle: RePEc:gla:glaewp:2013_06
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  1. William English & Kostas Tsatsaronis & Edda Zoli, 2005. "Assessing the predictive power of measures of financial conditions for macroeconomic variables," BIS Papers chapters, in: Bank for International Settlements (ed.), Investigating the relationship between the financial and real economy, volume 22, pages 228-52 Bank for International Settlements.
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  5. Gary Koop & Dimitris Korobilis, 2012. "Large time-varying parameter VARs," Working Papers 2012_04, Business School - Economics, University of Glasgow.
  6. Breitung, Jörg & Eickmeier, Sandra, 2011. "Testing for structural breaks in dynamic factor models," Journal of Econometrics, Elsevier, vol. 163(1), pages 71-84, July.
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  8. Doz, Catherine & Giannone, Domenico & Reichlin, Lucrezia, 2007. "A Two-Step Estimator for Large Approximate Dynamic Factor Models Based on Kalman Filtering," CEPR Discussion Papers 6043, C.E.P.R. Discussion Papers.
  9. Kaufmann, Sylvia & Schumacher, Christian, 2012. "Finding relevant variables in sparse Bayesian factor models: Economic applications and simulation results," Discussion Papers 29/2012, Deutsche Bundesbank, Research Centre.
  10. Anthony Garratt & Gary Koop & Emi Mise & Shaun Vahey, 2008. "Real-time Prediction with UK Monetary Aggregates in the Presence of Model Uncertainty," Reserve Bank of New Zealand Discussion Paper Series DP2008/13, Reserve Bank of New Zealand.
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  13. Koop, Gary & Korobilis, Dimitris, 2011. "Forecasting Inflation Using Dynamic Model Averaging," SIRE Discussion Papers 2011-40, Scottish Institute for Research in Economics (SIRE).
  14. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
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  16. Eickmeier, Sandra & Lemke, Wolfgang & Marcellino, Massimiliano, 2011. "The Changing International Transmission of Financial Shocks: Evidence from a Classical Time-Varying FAVAR," CEPR Discussion Papers 8341, C.E.P.R. Discussion Papers.
  17. Jean Boivin & Serena Ng, 2003. "Are More Data Always Better for Factor Analysis?," NBER Working Papers 9829, National Bureau of Economic Research, Inc.
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  21. 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.).
  22. 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.
  23. Eickmeier, Sandra & Lemke, Wolfgang & Marcellino, Massimiliano, 2011. "Classical time-varying FAVAR models - Estimation, forecasting and structural analysis," CEPR Discussion Papers 8321, C.E.P.R. Discussion Papers.
  24. Castelnuovo, Efrem, 2013. "Monetary policy shocks and financial conditions: A Monte Carlo experiment," Journal of International Money and Finance, Elsevier, vol. 32(C), pages 282-303.
  25. Dimitris Korobilis, 2013. "Assessing the Transmission of Monetary Policy Using Time-varying Parameter Dynamic Factor Models-super-," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 75(2), pages 157-179, 04.
  26. Stephan Danninger & Irina Tytell & Ravi Balakrishnan & Selim Elekdag, 2009. "The Transmission of Financial Stress From Advanced to Emerging Economies," IMF Working Papers 09/133, International Monetary Fund.
  27. Esteban Gómez & Andrés Murcia Pabón & Nancy Zamudio Gómez, . "Financial Conditions Index: Early and Leading Indicator for Colombia?," Temas de Estabilidad Financiera 055, Banco de la Republica de Colombia.
  28. Felices, Guillermo & Wieladek, Tomasz, 2012. "Are emerging market indicators of vulnerability to financial crises decoupling from global factors?," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 321-331.
  29. Carriero, Andrea & Kapetanios, George & Marcellino, Massimiliano, 2012. "Forecasting government bond yields with large Bayesian vector autoregressions," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2026-2047.
  30. Kimberly Beaton & René Lalonde & Corinne Luu, 2009. "A Financial Conditions Index for the United States," Discussion Papers 09-11, Bank of Canada.
  31. Scott Brave & R. Andrew Butters, 2011. "Monitoring financial stability: a financial conditions index approach," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 22-43.
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