Fuchun Li is a senior economist in the Model Development and Research Division of the Financial Stability Department at the Bank of Canada. His research interests are in econometric methods in finance, economics, and risk management. His current work mainly focuses on developing financial tools or financial stability assessment framework for the risk analysis of banking industry or Financial System. He received his PhD in economics from the University of Western Ontario.
We propose an early warning model for predicting the likelihood of a financial stress event for a given future time, and examine whether credit plays an important role in the model as a non-linear propagator of shocks.
The author proposes a test for the parametric specification of each component in the diffusion matrix of a d-dimensional diffusion process. Overall, d (d-1)/2 test statistics are constructed for the off-diagonal components, while d test statistics are constructed for the main diagonal components.
The objective of this paper is to propose an early warning system that can predict the likelihood of the occurrence of financial stress events within a given period of time. To achieve this goal, the signal extraction approach proposed by Kaminsky, Lizondo and Reinhart (1998) is used to monitor the evolution of a number of economic indicators that tend to exhibit an unusual behaviour in the periods preceding a financial stress event.
The authors use the Financial Stress Index created by the International Monetary Fund to predict the likelihood of financial stress events for five developed countries: Canada, France, Germany, the United Kingdom and the United States.