Financial Stress Index for Iran's Financial System with Portfolio Theory Approach

Financial Stress Index as a measure of a systemic risk that quantify stress throughout the entire financial system and describes the contribution of each section of the financial market to the overall stress of the system. In this paper, a composite index for measuring the stress of the Iran’s financial system proposed using a portfolio approach. This indicator is a combination of stress variables in different parts of the Iran’s financial system (stock market, debt market, banking sector, money market and exchange rate market). To aggregate these variables, EWMA, dynamic conditional correlation (DCC-GARCH) and BEKK-GARCH used to examine the cross-correlations structure between the subindices during the period of March 2010 to March 2018. In the end, to determine which of the stress indicators designed for the financial system of Iran is more desirable, the results of the prediction of the VAR model used to explain the changes in GDP. The results of the comparison of the prediction criteria showed that differences in the performance of these indices are not significant, although the stress index produced by BEKK-GARCH method performed better and in comparison with the other two methods used to estimate subindices cross-correlation, better explains the changes in the economy activity.