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Predicting financial stress events: A signal extraction approach

Author

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  • Christensen, Ian
  • Li, Fuchun
Abstract
The objective of this paper is to propose an early warning system that can predict the likelihood of the occurrence of financial stress events within a given period of time. To achieve this goal, the signal extraction approach proposed by Kaminsky et al. (1998) is used to monitor the evolution of a number of economic indicators that tend to exhibit unusual behavior in the periods preceding a financial stress event. Based on the individual indicators from 13 OECD countries, we propose three different composite indicators, the summed composite indicator, the extreme composite indicator and the weighted composite indicator. The in-sample forecasting results for the 13 OECD countries indicate that the three composite indicators are useful tools for predicting financial stress events, while none of them outperforms the others across all the criteria considered. The out-of-sample forecasting results suggest that for most of the 13 OECD countries, including Canada, the United Kingdom and the United States, the weighted composite indicator performs better than the two others across all the criteria considered.

Suggested Citation

  • Christensen, Ian & Li, Fuchun, 2014. "Predicting financial stress events: A signal extraction approach," Journal of Financial Stability, Elsevier, vol. 14(C), pages 54-65.
    • Handle: RePEc:eee:finsta:v:14:y:2014:i:c:p:54-65
    DOI: 10.1016/j.jfs.2014.08.005
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    References listed on IDEAS

    as
    1. Graciela Kaminsky & Saul Lizondo & Carmen M. Reinhart, 1998. "Leading Indicators of Currency Crises," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 1-48, March.
    2. Nicholas Bloom, 2009. "The Impact of Uncertainty Shocks," Econometrica, Econometric Society, vol. 77(3), pages 623-685, May.
    3. Diebold, Francis X & Rudebusch, Glenn D, 1989. "Scoring the Leading Indicators," The Journal of Business, University of Chicago Press, vol. 62(3), pages 369-391, July.
    4. 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.
    5. Ian Christensen & Fuchun Li, 2013. "A Semiparametric Early Warning Model of Financial Stress Events," Staff Working Papers 13-13, Bank of Canada.
    6. Davis, E. Philip & Karim, Dilruba, 2008. "Comparing early warning systems for banking crises," Journal of Financial Stability, Elsevier, vol. 4(2), pages 89-120, June.
    7. Mr. Subir Lall & Mr. Roberto Cardarelli & Mr. Selim A Elekdag, 2009. "Financial Stress, Downturns, and Recoveries," IMF Working Papers 2009/100, International Monetary Fund.
    8. Claudio Borio & Mathias Drehmann, 2009. "Assessing the risk of banking crises - revisited," BIS Quarterly Review, Bank for International Settlements, March.
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    10. 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, vol. 94(Q II), pages 5-50.
    11. Gneiting, Tilmann & Ranjan, Roopesh, 2011. "Comparing Density Forecasts Using Threshold- and Quantile-Weighted Scoring Rules," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(3), pages 411-422.
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    More about this item

    Keywords

    Cut-off probability; Early warning system; Financial crisis; Financial stress event; Signal extraction approach;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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