FCI DATA

We base the FCIs on a common information set composed of nine variables, namely (i) nominal long-term government bond yields; (ii) a set of four spreads, i.e., sovereign (for emerging economies only), corporate (for advanced economies only), inter-bank and term spreads (for all countries); (iii) realized equity volatility; (iv) the percentage change of equity and real residential house prices; (v) the growth rate of credit to households and non-profit institutions serving households; (vi) the bilateral exchange rate with the US dollar.

All variables are standardized before aggregation. We construct three sets of FCIs based on this common information set using different aggregation techniques, as follows:

1. EW-FCI (Equal Weights-FCI), constructed by aggregating the chosen indicators as simple (unweighted) averages.

2. PCA-FCI (Principal Component Analysis-FCI), constructed by aggregating the indicators through principal component, extracting the first one as the FCI. This aggregation method is widely used in the construction of FCIs (Kliesen et al., 2012; IMF, 2019).

3. TVP-FCI (Time-Varying Parameters-FCI), which summarizes the indicators through a (single) factor model with time-varying parameters, following Koop and Korobilis (2014) and Arregui et al. (2018).

Which FCI should you use?

In the paper we aimed at answering this question. An econometric evaluation, based on a large sample of countries, shows that FCIs obtained via equal weights combinations of financial variables have good statistical properties. They overall outperform alternative measures based on principal component analysis or factor models with time-varying parameters. The results hold both in the context of quantile regressions, where they prove useful in signaling downside risks to economic activity, as well as in probit models, where they show a stronger correlation with future banking crises. Importantly, for the euro area and for the USA, these simple indices outperform popular alternatives based on larger information sets and on different econometric methods, namely the Composite Index of Systemic Stress (CISS) for the euro area and the National Financial Conditions Index (NFCI) published by the Chicago Fed for the USA.