The simpler, the better: Measuring financial conditions for monetary policy and financial stability

Simone Arrigoni, Alina Bobasu and Fabrizio Venditti

No 2021/10, EIB Working Papers from European Investment Bank (EIB)

Abstract: In this paper we assess the merits of financial condition indices constructed using simple averages versus a more sophisticated alternative that uses factor models with time varying parameters. Our analysis is based on data for 18 advanced and emerging economies at a monthly frequency covering about 70% of the world's GDP.We assess the performance of these indicators based on their ability to capture tail risk for economic activity and to predict banking and currency crises. We find that averaging across the indicators of interest, using judgmental but intuitive weights, produces financial condition indices that are not inferior to, and actually perform better than, those constructed with more sophisticated statistical methods. An indicator that gives more weight to measures of financial stress, which we term WA-FSI, emerges as the best indicator for anticipating banking crisis, and is therefore better suited for financial stability.

Keywords: financial conditions; quantile regressions; banking crises; SVARs; spillovers (search for similar items in EconPapers)
JEL-codes: C11 C55 E32 E44 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-ban, nep-fdg, nep-ifn, nep-mac and nep-mon
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https://www.econstor.eu/bitstream/10419/245959/1/1775863212.pdf (application/pdf)

Related works:
Working Paper: The simpler the better: measuring financial conditions for monetary policy and financial stability (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:eibwps:202110

DOI: 10.2867/149278

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