China Financial Stress Index under Correlations between Markets

Abstract

Abstract:

High tension in the financial system will affect its resource allocation function and further lead to economic downturns. An extreme state of financial stress is the financial crisis. Financial stress index has become an important instrument and reference index to evaluate the efficiency of monetary policy and instability of the financial system. However, in the construction process of index, selection of indicators, data frequency and aggregation methods, there does not exist a unified standard. Financial stress index in existing studies is generally constructed based on monthly data, which leads to some limits in timeliness. As a result, it cannot provide enough immediate and effective information to assist the decision-making. Eleven daily indicators of money, bond, equity and exchange markets are chosen to construct financial stress index in China after investigating the existing literature. When aggregating these indicators, basic weights of four sub-markets are determined according to their influence on economy. Further, similar to portfolio theory, a time-varying correlation between different sub-markets is introduced to ensure time-varying characteristic of weight. Validity of the constructed index is verified through an analysis of stress events in the financial system of China, so this finding lays a foundation for further studies.

Key words: financial stress, high-frequency data, time-varying structure, portfolio theory

Yao Xiaoyang, Sun Xiaolei, Li Jianping. China Financial Stress Index under Correlations between Markets[J]. , 2019, 31(4): 34-41.

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