Development of “JCER Financial Stress Index”
The Japan Center for Economic Research has recently developed the JCER Financial Stress Index as an indicator of the rise in financial "systemic risk" and has started to publish the latest figures. This index is a useful indicator for detecting a recurrence of financial crisis, such as the financial instability in the late 1990s and the 2008 Lehman Shock. The index has soared recently, reflecting the turmoil in financial markets due to the pandemic of the novel coronavirus, and equivalent to the eve of the 2008 global financial crisis.
Financial "systemic risk" refers to the risk that the financial system as a whole will malfunction due to some trigger event, such as the current corona crisis or the failure of a financial institution, which will have a serious adverse effect on the real economy. The JCER Financial Stress Index, based on the “Composite Indicator of Systemic Stress” developed by European Central Bank (ECB), is constructed by compositing fifteen individual financial market indicators, including stock price and its volatility, bond yields, and exchange rate changes (refer to Table A1 below). Quantitatively understanding which markets are responsible for the increased financial stress enables us to provide guidance to policy implementation by fiscal and monetary authorities.
Recent developments of the JCER Financial Stress Index
Financial stress has risen during the financial system instability of 1997-98 and the Global Financial Crisis (GFC) of 2007-08. As for recent years, the stress level rose in 2016, when major events including the slowdown of emerging economies such as China, the introduction of the BOJ’s negative interest rate policy, and the withdrawal of the United Kingdom from the EU (Brexit) overlapped (Figure below).
It has risen recently, reflecting the spike of volatility in the financial markets caused by the Corona Crisis, with the latest financial stress index of 0.291 as of April 10, 2020. This is equivalent to the level of the “Eve of the GFC" which corresponds to the period from the Paribas shock in August 2007 and the bailout of Bear Stearns in March 2008 to the Lehman shock.
The Japan Center for Economic Research set a general rule to update the index about once a week. When significant fluctuations in the financial markets occur, we are to update and publish the index temporarily using daily data.
Underlying data used to estimate the JCER Financial Stress Index
Financial stress indexes and systemic risk indicators published by various organizations
Japan Center for Economic Research, 2019. “Risks in the BOJ’s ETF Purchases and Regional Financial Institutions - A stress event could reignite financial system anxiety,” FY 2019 Financial Research Report II: Overhauling Financial Risks in Japan (No. 41), February 12, 2020. (members only).
Holló, D., Kremer, M. and Lo Duca, M., 2012. “CISS - A Composite Indicator of Systemic Stress in the Financial System,” Working Paper Series, No. 1426, European Central Bank, March 2012.
－BOJ relaxes yield curve control, Fed's rate-hike phase expected to end
－Financial stress maintains a low level since the yen's depreciation is stopped due to narrowing interest rate difference between Japan and the U.S.
－BOJ continues with current monetary easing, Fed leaves interest rates unchanged but expects an additional hike before the end of the year
－Financial stress remains a low level with the yen slowly weakening and stock prices remaining at high levels
－ Both of central banks in the U.S. and Euro area hiked interest rate, BOJ also made YCC policy more flexible and raise the upper bound of long-term interest rate
－ Financial stress maintains a low level as weakening yen and high stock prices are maintained, but uncertainty about outlook still remains
－ TOPIX keeps at its highest level in about 33 years and financial stress remains a low level
－ Banking stocks are steady on expectations of an early revision of the BOJ's easing policy, while the yen depreciates at its weakest level in about seven months
－ TOPIX is at its highest level in about 33 years since the bubble period and financial stress keeps a low level
－ While Japanese yen was weakening due to the widening interest rate differential, the U.S. debt ceiling issue reached a tentative agreement to avert a default on U.S. Treasuries