econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 06 January 2018

A Tool To Gauge The Health Of Financial Markets

from the St Louis Fed

How does one take the temperature of financial markets? One tool is something called a financial conditions index, which is an indicator of financial stress.

Interest in this type of index grew after the housing bubble burst and the subsequent financial crisis led to the worst recession since the Great Depression.

Economist Paulina Restrepo-Echavarriaand Research Associate Brian Reinbold looked at how these indexes are constructed and compared some of the most widely used indexes.

The authors noted that the indexes incorporate various financial variables and typically use either a weighted average of those variables or a statistical technique called principal component analysis (PCA).

“The goal is for the index to summarize information about the future using current financial variables, providing insight into the health of financial markets," they wrote.

Marching in Lockstep?

The authors noted that the five most widely used financial indexes are:

  • St. Louis Fed Financial Stress Index (STLFSI)
  • Kansas City Financial Stress Index (KCFSI)
  • Chicago Fed National Financial Conditions Index (NFCI)
  • Bloomberg Financial Conditions Index (BFCI)
  • Goldman Sachs Financial Conditions Index (GSFCI)

The table below lists correlations between the indexes themselves and the indexes’ correlations with the CBOE Volatility Index (VIX). The VIX is a popular method to gauge the financial markets. It is based on option prices for the benchmark S&P 500 stock index, and it serves as a measure of market expectations of near-term volatility.

Cross-Correlations of Financial Conditions Indexes
STLFSIKCFSINFCIGSFCIBFCIVIX
STLFSI10.730.720.470.580.69
KCFSI0.7310.950.480.890.86
NFCI0.720.9510.570.870.80
GSFCI0.470.480.5710.430.45
BFCI0.580.890.870.4310.83
VIX0.690.860.800.450.831
SOURCES: FRED, Federal Reserve Bank of St. Louis; Bloomberg; and authors' calculations.
Federal Reserve Bank of St. Louis

Indexes May Move Differently

The authors explained why these indexes may or may not follow each other closely.

  • The Kansas City and the Chicago Fed financial indexes are the most correlated since they use many of the same broad categories of financial variables - such as various Treasury and bond-yield spreads - and are constructed using PCA.
  • On the other extreme, the Goldman Sachs index is less correlated with the other indexes because it uses a narrower set of financial variables.

Other than the Goldman Sachs index, the other indexes are also strongly correlated to the VIX, which makes sense since they incorporate the VIX, the authors said. (To view how these indexes have moved since 1990, see the chart in the Economic Synopsesarticle, “Financial Conditions Indexes.")

While some of the indexes have common elements and relatively high correlations, others do not, Restrepo-Echavarria and Reinbold observed.

“As a result, anyone interested in using financial conditions indexes as indicators of financial stress would benefit from looking at several indexes and not just one," they said.

Additional Resources

Source

https://www.stlouisfed.org/on-the-economy/2017/december/tool-gauge-health-financial-markets

Disclaimer

Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.




Econintersect Contributors








search_box
Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.







Keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government




























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2018 Econintersect LLC - all rights reserved