Monitoring Financial Stability in Emerging and Frontier Markets

27 Pages Posted: 2 Jun 2017

See all articles by David Bicchetti

David Bicchetti

United Nations - Conference on Trade and Development (UNCTAD)

David Neto

Independent

Date Written: May 17, 2017

Abstract

This paper outlines a methodology to build monthly financial conditions indicators (FCIs) for developing countries, including a Small Island Developing State (SIDS), least developed countries, and transitions economies as defined by the United Nations’ classification. The proposed composite index uses ragged-edge panel data as well as mixed frequency observations. FCIs are compiled using a Dynamic Factor Analysis (DFA) in order to create a synthetic index in real time (as data is released). Also the choice of variables reflects typical emerging markets considerations given to interdependency issues and include variables like capital flows and real effective exchange rates. We show, that the obtained indicators are able to capture periods of financial stress and near-miss events historically. In addition, although our FCIs are free from the business cycle, it is able to track GDP growth, in several cases with a clear leading effect. Our FCIs are therefore an interesting tool for policymakers and market participants alike since its predictive power allows them to assess financial stability in real time before financial shocks are transmitted to the real economy. Consequently, upcoming stormy macroeconomic conditions can be anticipated well ahead.

Keywords: Financial markets, emerging and frontier markets, dynamic factor models, mixed-frequency observations, Kalman smoother, financial stress indicators, financial crisis, real-time information flow tracking, leading indicators

JEL Classification: C13, C32, C43, D53, E32, E44, F32, F47, G18

Suggested Citation

Bicchetti, David and Neto, David, Monitoring Financial Stability in Emerging and Frontier Markets (May 17, 2017). Available at SSRN: https://ssrn.com/abstract=2978196 or http://dx.doi.org/10.2139/ssrn.2978196

David Bicchetti (Contact Author)

United Nations - Conference on Trade and Development (UNCTAD) ( email )

Palais des Nations
Office E 8074
Geneva, 1211
Switzerland

David Neto

Independent ( email )

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