Weighting Methods for Financial Stress Indices - Comparison and Implications for Risk Management

Journal of Financial Management and Analysis, Volume 25, No. 2, July-December, 2012

Posted: 20 Mar 2013

See all articles by Dieter Gramlich

Dieter Gramlich

Baden-Wuerttemberg Cooperative State University Mosbach (DHBW)

Timothy Bianco

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Mikhail V. Oet

Case Western Reserve University - Weatherhead School of Management; Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: 2012

Abstract

Financial stress indices (FSIs) involve the weighting and compilation of different sub-indices and indicators into an overall measure of systemic stress. Despite the importance of weighting with regard to the relevance of single indices or indicators (structural effect), the behavior of the overall index over time (dynamic effect) and further consequences from applications of the FSI, the effects of weighting have rarely been investigated in a systematic way. Therefore, this study focuses on the effects that different weighting methods have on the construction and interpretation of FSIs. Six weighting approaches are compared on a conceptual and empirical basis. Based on the aggregation of time series for different sub-indices and indicators from 1991 to 2011, it is shown that weighting impacts the composition and the behavior of an FSI. Strategies for risk management and supervision based on FSIs have to take these effects into account and choose weighting methods accordingly.

Keywords: Financial stress index, Weighting, Market transparency, Systemic risk, Risk alerts

JEL Classification: C50, E50, G01, G10

Suggested Citation

Gramlich, Dieter and Bianco, Timothy and Oet, Mikhail V., Weighting Methods for Financial Stress Indices - Comparison and Implications for Risk Management (2012). Journal of Financial Management and Analysis, Volume 25, No. 2, July-December, 2012, Available at SSRN: https://ssrn.com/abstract=2235750

Dieter Gramlich (Contact Author)

Baden-Wuerttemberg Cooperative State University Mosbach (DHBW) ( email )

Lohrtalweg 10
Mosbach, 74821
Germany

Timothy Bianco

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Mikhail V. Oet

Case Western Reserve University - Weatherhead School of Management ( email )

364 PBL Building
Cleveland, OH 44106
United States

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States
216.774.2684 (Phone)
216.579.2932 (Fax)

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