Dating systemic financial stress episodes in the EU countries

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. iii Terms of use: Documents in EconStor may AbstractThis paper introduces a new methodology to date systemic financial stress events in a transparent, objective and reproducible way. The financial cycle is captured by a monthly country-specific financial stress index. Based on a Markov-switching model, high financial stress regimes are identified, and a simple algorithm is used to select those episodes of financial stress that are associated with a substantial negative impact on the real economy. By applying this framework to 27 European Union countries, the paper is a first attempt to provide a chronology of systemic financial stress episodes in addition to the expert-detected events that are currently available. Non-Technical SummaryIt is widely agreed that the global financial crisis that started in 2007 was an episode of severe financial market stress, which spilled over to the real economy causing the Great Recession. However, it is much more difficult to identify and classify other periods of, possibly systemic, financial market stress. The expert-based approach to identifying episodes of systemic financial stress prevails so far, but an objective and reproducible method for the detection of periods of low and high financial stress is lacking. A comprehensive analysis of the succession of tranquil and stress periods is a prerequisite to determining the leading indicators of systemic financial stress and evaluating the effectiveness of prudential policies implemented over the course of the financial cycle. This paper provides a new framework for a transparent and objective identification of systemic financial stress episodes, i.e., periods of high financial stress associated with a substantial and prolonged decline in real economic activity. By applying the framework to the countries of the European Union (EU), this is the first paper to build a consistent monthly chronology of EU systemic financial stress episodes beyond the expert-detected crises currently available. In fact, a continuous measure of financial stress is converted into a binary systemic stress dummy, commonly used in early-warning models.The model-based framework consists of three steps. First, we build on the existing financial stress literature and construct a simple country-specific financial stress index for 27 EU countries starting as early as 1964 for core EU countries. The essential feature of the financial stress index is that it captures co-movements in key financial market...

House prices in the euro area

“…. Quarterly country-level index of Þ nancial stress was calculated as a simple average of monthly levels of the country-level index of Þ nancial stress as developed and calculated by Duprey et al (2015); this index is constructed to reß ect volatility in three Þ nancial market segmentsequity market, bond market and foreign exchange market (see Duprey et al (2015) Observing the Þ gures, the heterogenous dynamics of the observed variables becomes evident. Application of regression estimation methods that account for heterogeneity is therefore well-suited.…”

“…In countries more affected by the economic and Þ nancial market stress episodes, including Greece, Ireland, Italy, Portugal, and Spain, the drop in house prices has been more pronounced. The latter group of countries also experienced a sharper deterioration of macroeconomic activity 3 than the Þ rst group of countries and a "systemic Þ nancial stress that expanded beyond global Þ nancial crisis" (Duprey et al, 2015). Ample international empirical evidence (e.g.…”

“…It is still not documented in the literature how a more broadly deÞ ned Þ nancial market uncertainty that reß ects uncertainty in several segments of Þ nancial assets markets affects house prices in the euro area. Recently, Duprey et al (2015) deÞ ned the Country-Level Index of Financial Stress (CLIFS); an indicator that measures Þ nancial market stress 5 in three segments of individual euro area countries' Þ nancial markets: the equity, bond, and foreign exchange markets.…”

Is there a trade-off between free capital mobility, financial stability and fiscal policy flexibility in the EMU?

“…As the two financial stability indexes employed so far rely on the same logic for their calculation, we also estimate the trilemma indicator by employing a different Duprey et al (2015). This indicator is obtained on the basis of the stress on three financial market segments (equity, bond and foreign exchange rate) by using two variables for each segment.…”

Are Euro-Area expectations about recession phases effective to anticipate consequences of economic crises?

“…To do so, we include the Country-level index of Financial Stress (CLIFS) as a covariant in the MS-AR model. This index measures the uncertainty in market prices by identifying simultaneous financial market turmoil across different assets (see Duprey et al 2017 for more details). 19 Finally, the ESI responses are not revised ex-post as most macroeconomic aggregates.…”