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Financial Conditions Index: Early and Leading Indicator for Colombia

Esteban Gómez (), Andrés Murcia () and Nancy Zamundio ()

Revista ESPE - Ensayos sobre Política Económica, 2011, vol. 29, issue 66, No 66, 174-220

Abstract: This paper is an attempt at constructing a simple and effective macroprudential tool for policymakers. By integrating the joint occurrences of the main financial markets in Colombia into a single Financial Conditions Index (FCI), we hope to synthesize the information embedded in them regarding possible future economic outcomes. To do this, we use monthly data on 21 variables for the period comprised between July, 1991 - June, 2010 and apply Principal Component Analysis (PCA) on their correlation matrix. On the one hand, we evaluate the predictive capacity of the FCI in forecasting GDP growth at different time horizons and find that it performs better as a leading indicator of real activity than other individual financial variables and an autoregressive model of GDP growth. Additionally, we are interested in testing the FCI’s long-term capability to correctly anticipate periods of distress in the economy, and find that the index could be used as an effective early-warning indicator. Hence, our FCI seems to represent a useful instrument for both financial stability and macroprudential supervision purposes.

Keywords: financial conditions index; Early-Warning Indicators; leading indicators; Macroprudential Supervision; principal component analysis (search for similar items in EconPapers)
JEL-codes: E32 E44 E47 E51 (search for similar items in EconPapers)
Date: 2011
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