A UK Financial Conditions Index Using Targeted Data Reduction: Forecasting and Structural Identification

32 Pages Posted: 13 Sep 2017

See all articles by George Kapetanios

George Kapetanios

King's College, London

Simon Price

Essex Business School; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

Garry Young

ESCOE

Multiple version iconThere are 2 versions of this paper

Date Written: September 5, 2017

Abstract

A financial conditions index (FCI) is designed to summarise the state of financial markets. We construct two with UK data. The first is the first principal component (PC) of a set of financial indicators. The second comes from a new approach taking information from a large set of macroeconomic variables weighted by the joint covariance with a subset of the financial indicators (a set of spreads), using multivariate partial least squares, again using the first factor. The resulting FCIs are broadly similar. They both have some forecasting power for monthly GDP in a quasi-real-time recursive evaluation from 2011-2014 and outperform an FCI produced by Goldman Sachs. A second factor that may be interpreted as a monetary conditions index adds further forecast power, while third factors have a mixed effect on performance. The FCIs are used to improve identification of credit supply shocks in an SVAR. The main effects relative to an SVAR excluding an FCI of the (adverse) credit shock IRFs are to make the positive impact on inflation more precise and to reveal an increased positive impact on spreads.

Keywords: Forecasting, Financial conditions index, Targeted data reduction, Multivariate partial least squares, Credit shocks

JEL Classification: C53

Suggested Citation

Kapetanios, George and Price, Simon G. and Young, Garry, A UK Financial Conditions Index Using Targeted Data Reduction: Forecasting and Structural Identification (September 5, 2017). CAMA Working Paper No. 58/2017, Available at SSRN: https://ssrn.com/abstract=3035653 or http://dx.doi.org/10.2139/ssrn.3035653

George Kapetanios

King's College, London ( email )

30 Aldwych
London, WC2B 4BG
United Kingdom
+44 20 78484951 (Phone)

Simon G. Price (Contact Author)

Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

Garry Young

ESCOE ( email )

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