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Financial stress and economic dynamics: an application to France

  • Sofiane Aboura
  • Björn van Roye

In this paper, we develop a financial stress index for France that can be used as a real-time composite indicator for the state of financial stability in France. We take 17 financial variables from different market segments and extract a common stress component using a dynamic approximate factor model. We estimate the model with a combined maximum-likelihood and Expectation-Maximization algorithm allowing for mixed frequencies and an arbitrary pattern of missing data. Using a Markov-Switching Bayesian VAR model, we show that an episode of high financial stress is associated with significantly lower economic activity, whereas movements in the index in a low-stress regime do not incur significant changes in economic activity. Therefore, this index can be used in real time as an early warning signal of systemic risk in the French financial sector

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Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1834.

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Length: 29 pages
Date of creation: Mar 2013
Date of revision:
Handle: RePEc:kie:kieliw:1834
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  1. Susanto Basu & Brent Bundick, 2011. "Uncertainty Shocks in a Model of Effective Demand," Boston College Working Papers in Economics 774, Boston College Department of Economics, revised 01 Nov 2015.
  2. Bańbura, Marta & Modugno, Michele, 2010. "Maximum likelihood estimation of factor models on data sets with arbitrary pattern of missing data," Working Paper Series 1189, European Central Bank.
  3. Sims, Christopher A. & Waggoner, Daniel F. & Zha, Tao, 2008. "Methods for inference in large multiple-equation Markov-switching models," Journal of Econometrics, Elsevier, vol. 146(2), pages 255-274, October.
  4. Scott Brave & R. Andrew Butters, 2012. "Diagnosing the Financial System: Financial Conditions and Financial Stress," International Journal of Central Banking, International Journal of Central Banking, vol. 8(2), pages 191-239, June.
  5. Björn van Roye, 2011. "Financial stress and economic activity in Germany and the Euro Area," Kiel Working Papers 1743, Kiel Institute for the World Economy.
  6. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, 05.
  7. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  8. Illing, Mark & Liu, Ying, 2006. "Measuring financial stress in a developed country: An application to Canada," Journal of Financial Stability, Elsevier, vol. 2(3), pages 243-265, October.
  9. Kliesen, Kevin L. & Owyang, Michael T. & Vermann, E. Katarina, 2012. "Disentangling diverse measures: a survey of financial stress indexes," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 369-398.
  10. Simon Gilchrist & Egon Zakrajšek, 2011. "Credit Spreads and Business Cycle Fluctuations," NBER Working Papers 17021, National Bureau of Economic Research, Inc.
  11. Cardarelli, Roberto & Elekdag, Selim & Lall, Subir, 2011. "Financial stress and economic contractions," Journal of Financial Stability, Elsevier, vol. 7(2), pages 78-97, June.
  12. Robert Tetlow & Kirstin Hubrich, 2013. "Financial stress and economic dynamics: The transmission of crises," 2013 Meeting Papers 571, Society for Economic Dynamics.
  13. Claudio Borio, 2011. "Central banking post-crisis: What compass for uncharted waters?," BIS Working Papers 353, Bank for International Settlements.
  14. Holló, Dániel & Kremer, Manfred & Lo Duca, Marco, 2012. "CISS - a composite indicator of systemic stress in the financial system," Working Paper Series 1426, European Central Bank.
  15. Craig S. Hakkio & William R. Keeton, 2009. "Financial stress: what is it, how can it be measured, and why does it matter?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 5-50.
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