Forecasting Financial Stress Indices in Korea: A Factor Model Approach

Kim, Hyeongwoo and Shi, Wen and Kim, Hyun Hak (2018): Forecasting Financial Stress Indices in Korea: A Factor Model Approach.

Abstract

We propose factor-based out-of-sample forecast models for Korea's financial stress index and its 4 sub-indices that are developed by the Bank of Korea. We extract latent common factors by employing the method of the principal components for a panel of 198 monthly frequency macroeconomic data after differencing them. We augment an autoregressive-type model of the financial stress index with estimated common factors to formulate out-of-sample forecasts of the index. Our models overall outperform both the stationary and the nonstationary benchmark models in forecasting the financial stress indices for up to 12-month forecast horizons. The first common factor that represents not only financial market but also real activity variables seems to play a dominantly important role in predicting the vulnerability in the financial markets in Korea.

• Item Type: MPRA Paper
• Language: English
• Keywords: Financial Stress Index; Principal Component Analysis; PANIC; In-Sample Fit; Out-of-Sample Forecast; Diebold-Mariano-West Statistic
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E47 - Forecasting and Simulation: Models and Applications; G - Financial Economics > G0 - General > G01 - Financial Crises; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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