Global Financial Stability Index

Abstract

We develop a monthly Global Financial Stability Index (GFSX) that incorporates the global stock market outlook, momentum, and overall risk. Refining the financial stability concept presents challenges because of the many different approaches researchers have pursued, as well as the availability of periodic data. The stock market is the nervous system for the overall economy that anticipates key issues with a precision of some months to the future, especially pitfalls in the financial system, so we use time series data of 23 countries to form global financial market portfolios and create a measure of risk adjusted financial stability (risk adjusted stationary probability for a good state) that predicts future stability. The intuition behind our GFSX model is that we view financial stability as the likelihood that the financial market will operate in a steady state that reflects global risk and momentum. We also develop regional financial stability indexes, including Europe and Asia, and we examine the cross sectional sensitivity of industry sectors to the GFSX. Our results show that the regional financial stability indexes are highly correlated with GFSX, furthermore, our GFSX provides information that existing indexes do not (such as VIX). We also demonstrate that there is significant variation in conditional GFSX sensitivity across some sectors: specifically, sectors Toys, Recreation, Smoke Tobacco Products, and Mines Non-Metallic are positively sensitive to financial stability; while sectors Soda, Candy, Coal, and Gold and Precious Metals are industries that are negatively sensitive to financial stability.