We apply the growth-at-risk framework to the Australian economy. This allows us to estimate how important current financial conditions are in explaining future downside risk to key macroeconomic variables. As such, it provides a way to quantify the economic costs of financial instability. In order to implement this framework, we develop a new financial conditions index for Australia and show that it correlates closely with previous episodes of financial instability. We find that more restrictive financial conditions play an important role in explaining downside risk to growth in both GDP and employment and upside risk to changes in the unemployment rate. Our measure of financial conditions is, however, less useful for explaining risks to growth in household consumption and business investment. Overall, the framework provides a useful characterisation of the relationship between financial stability and economic activity in Australia.
Based on a dynamic factor model for a data set with more than 100 variables, we find that macroeconomic fluctuations in Australia can be largely captured by just two common factors. However, the factor structure changed soon after the introduction of inflation targeting in the 1990s, resulting in a large reduction in cross‐sectional variation related to these common factors. Estimates from a block‐exogenous factor‐augmented vector autoregressive model suggest that the transmission and responsiveness of monetary policy also changed, with policy both more effective and responsive to the potential inflationary impacts of shocks following the introduction of inflation targeting.
The factor structure of the U.S. economy appears to change over time. Unlike previous studies which suggest this is due to permanent structural breaks in factor loadings, I argue instead that the volatility and persistence of factor processes undergo recurring changes related to the business cycle. To capture this, I develop a two-step Markov-switching static factor estimation procedure and apply it to a well studied U.S. macroeconomic data set. I find strong support for Markov-switching in the factors processes, with switching variances being most dominant. Conditional on Markov-switching factor processes, tests for regime-dependent factor loadings show only moderate evidence of change. Overall, the results support regime-dependent factor processes as the main explanation for the diverging number of estimated factors in empirical applications and challenge the global linearity assumption implicit in large dimensional factor models of the U.S. economy.
HAC estimators are known to produce test statistics that reject too frequently in finite samples. One neglected reason comes from using the OLS residuals when constructing the HAC estimator. If the regression matrix contains high leverage points, such as from outliers, then the OLS residuals will be negatively biased. This reduces the variance of the OLS residuals and the HAC estimator takes this to signal a more accurate coefficient estimate. Transformations to reflate the OLS residuals and offset the bias have been used in the related HC literature for many years, but these have been overlooked in the HAC literature. Using a suite of simulations I provide strong evidence in favour of replacing the OLS residual-based HAC estimator with estimators related to extensions of either of the two main HC alternatives. In an empirical application I show how different inference from using the alternative HAC estimators can be important, not only from a statistical perspective, but also from an economic one as well.
PurposeThe Australian REIT (A‐REIT) market has undergone significant change over the past ten years with a shift from passive investment strategies to more active investment strategies in an attempt to deliver higher return performance. However, this has dramatically changed the risk characteristics of A‐REITs. Essentially, the sector has become more risky. Factors contributing to the increasing risk profile include: rising gearing levels; greater offshore exposure; evolving management structure towards stapled trusts, and growing market concentration. This paper aims to address these issues.Design/methodology/approachIn an attempt to gauge the impact of the changing risk characteristics over time the paper employs two formal risk measures: time‐varying beta and news impact curves. Both measures indicate that the sector has become more risky. Indeed, it could be argued that the pronounced fall in A‐REIT prices during late 2007 reflects a re‐rating of risk on the upside. The post credit crisis financial climate warrants a review of investment strategies; in particular, growth style investments that may be carrying a high level of embedded risk and opaque income streams.FindingsCurrent market sentiment suggests that investors have become more risk averse, and as such, will refocus on A‐REITs that cater for defensive style investments. Such vehicles will have low to moderate gearing levels, hold quality property assets in their portfolio, limited off‐shore exposure, and employ sound management practices.Originality/valueThe heightened risk‐averse environment presents opportunities for new investment products that provide partial exposure to direct property investment as a way to mitigate excessive equity market volatility.
We develop a new financial conditions index for Australia and use it to apply the growth‐at‐risk framework to the Australian economy. The index correlates closely with previous episodes of financial instability and allows us to estimate how important current financial conditions are in explaining future downside risk to key macroeconomic variables. As such, it provides a way to quantify the economic costs of financial instability. We find that more restrictive financial conditions play an important role in explaining downside risk to growth in both gross domestic product and employment and upside risk to changes in the unemployment rate. Our measure of financial conditions is, however, less useful for explaining risks to growth in household consumption and business investment. Overall, the framework provides a useful characterisation of the relationship between financial stability and economic activity in Australia.
scite is a Brooklyn-based organization that helps researchers better discover and understand research articles through Smart Citations–citations that display the context of the citation and describe whether the article provides supporting or contrasting evidence. scite is used by students and researchers from around the world and is funded in part by the National Science Foundation and the National Institute on Drug Abuse of the National Institutes of Health.