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Identifying a financial conditions index for South Africa

Kirsten Thompson (), Renee van Eyden () and Rangan Gupta ()
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Kirsten Thompson: Department of Economics, University of Pretoria

No 201333, Working Papers from University of Pretoria, Department of Economics

Abstract: The global financial crisis that began in 2007-08 demonstrated how severe the impact of financial markets’ stress on real economic activity can be. In the wake of the financial crisis policy-makers and decision-makers across the world identified the critical need for a better understanding of financial conditions, and more importantly, their impact on the real economy. To this end, we have constructed a financial conditions index (FCI) for the South African economy, to enable the gauging of financial conditions and to better understand the macro-financial linkages in the country. The FCI is constructed using monthly data over the period 1966 to 2011, and is based on a set of sixteen financial variables, which include variables that define the state of international financial markets, asset prices, interest rate spreads, stock market yields and volatility, bond market volatility and monetary aggregates. We explore different methodologies for constructing the FCI, and find that rolling-window principal components analysis (PCA) yields the best result. We furthermore investigate whether it is beneficial to purge the FCI of the real effects of inflation, economic growth and interest rates, and use the identified FCI in in-sample causality testing with three macroeconomic variables.

Keywords: financial conditions; financial crisis; principal components (search for similar items in EconPapers)
JEL-codes: C32 C52 C53 G01 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2013-07
New Economics Papers: this item is included in nep-afr
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