Measuring financial stress in a developed country: An application to Canada

Abstract This paper develops an index of financial stress for the Canadian financial system. It is a continuous variable with a spectrum of values, where extreme values are called financial crises. An internal Bank of Canada survey is used to condition the choice of variables. The authors show that alternative measures of financial crisis suggested by the literature do not accurately reflect the Canadian experience, while several measures developed in this paper are more representative and are thus likely better suited to a developed financial system. An accurate characterization of stress is a prerequisite for any researcher attempting to forecast financial crises.

[1]  M. Gertler,et al.  Interest Rate Spreads, Credit Constraints, and Investment Fluctuations: An Empirical Investigation , 1990 .

[2]  Asani Sarkar,et al.  Crises in Developed and Emerging Stock Markets , 1998 .

[3]  G. Wood,et al.  Financial crises and the world banking system , 1986 .

[4]  John V. Duca.  What Credit Market Indicators Tell Us , 1999 .

[5]  R. Chou,et al.  ARCH modeling in finance: A review of the theory and empirical evidence , 1992 .

[6]  David C. Wheelock,et al.  Aggregate Price Shocks and Financial Instability: An Historical Analysis , 2000 .

[7]  Andrew K. Rose,et al.  Currency crashes in emerging markets: An empirical treatment , 1996 .

[8]  Andrés Velasco,et al.  Financial Crises in Emerging Markets: The Lessons from 1995 , 1996 .

[9]  D. Hardy,et al.  Determinants and Leading Indicators of Banking Crises: Further Evidence , 1999 .

[10]  Carmen M. Reinhart,et al.  The Twin Crises: The Causes of Banking and Balance-of-Payments Problems , 1996 .

[11]  Hali J. Edison,et al.  Do Indicators of Financial Crises Work? An Evaluation of an Early Warning System , 2000 .

[12]  Brenda González-Hermosillo,et al.  Determinants of Ex-Ante Banking System Distress: A Macro-Micro Empirical Exploration of Some Recent Episodes , 1999, SSRN Electronic Journal.

[13]  Serena Ng,et al.  The Risky Spread, Investment, and Monetary Policy Transmission: Evidence on the Role of Asymmetric Information , 1996 .

[14]  D. Klingebiel,et al.  Bank Insolvencies: Cross-Country Experience , 1996 .

[15]  D. Tessier,et al.  Quelques résultats empiriques relatifs à l'évolution du taux de change Canada/États-Unis , 2000 .

[16]  A. Demirguç-Kunt,et al.  The Determinants of Banking Crises in Developing and Developed Countries , 1998 .

[17]  Luis Cortavarria-Checkley,et al.  Loan Review, Provisioning, and Macroeconomic Linkages , 2000, SSRN Electronic Journal.

[18]  Paolo A. Pesenti,et al.  Paper Tigers? a Model of the Asian Crisis , 1998 .

[19]  A. Vila.  Asset price crises and banking crises: some empirical evidence , 2000 .

[20]  J. Hawkins,et al.  Measuring Potential Vulnerabilities in Emerging Market Economies , 2000 .

[21]  Steven B. Kamin.  The Current International Financial Crisis: How Much is New? , 1999 .

[22]  M. Bordo,et al.  Measuring Real Economic Effects of Bailouts: Historical Perspectives on How Countries in Financial Distress Have Fared with and Without Bailouts , 2000 .

[23]  Carmen M. Reinhart,et al.  Leading Indicators of Currency Crises , 1997, SSRN Electronic Journal.

[24]  Simon van Norden,et al.  Terms of trade and real exchange rates: the Canadian evidence , 1995 .

[25]  Pierre Monnin,et al.  Measuring and forecasting stress in the banking sector: evidence from Switzerland , 2005 .

[26]  Francesco Caramazza,et al.  Trade and financial contagion in currency crises , 2000 .