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Prepared by Mehdi Raissi and Paul Cashin.
The FSI for advanced countries is constructed by Cardarelli et al (2009) as an average of the following indicators: the “beta” of banking sector stocks; TED spread; the slope of the yield curve; corporate bond spreads; stock market returns; time-varying stock return volatility; and time-varying effective exchange rate volatility. Such an index facilitates the identification of large shifts in asset prices (stock and bond market returns); an abrupt increase in risk/uncertainty (stock and foreign exchange volatility); liquidity tightening (TED spreads); and the health of the banking system (the beta of banking sector stocks and the yield curve).
One unit of FSI is equivalent to one standard deviation. This index measures price movements relative to trend, with a historical average value of zero (implying neutral financial market conditions). The magnitude of the shock is comparable to the 2002 episode of market volatility in AMs and is much smaller than the GFC shock.