Designing a Financial Stress Index Based on Global Volatility and Its Relationship with the VIX Index

Document Type : Original Article

Authors

1 Department of Financial Management, Central Tehran Branch, Islamic Azad University, Tehran, Iran.

2 Department of Financial Management, Central Tehran Branch, Islamic Azad University, Tehran, Iran,

10.30495/ijfma.2023.75091.2058

Abstract

Financial stress can be considered a disruption in the normal functioning of financial markets and its indicators are essential tools for assessing the stability and vulnerability of financial systems. This research focuses on designing and explaining a comprehensive financial stress index that incorporates external financial indicators and provides a comprehensive outlook on systemic risks facing an economy in the time span from October 31, 2012, to October 21, 2022. In this research, five important global indicators—Brent crude oil price, gold price per ounce, the U.S. Dollar index, the NASDAQ Composite index, and the Euro to Dollar exchange rate—have been used to construct the financial stress index. Various methods such as principal component analysis and statistical regression models are employed to determine optimal weights. Sensitivity analysis is performed to ensure the stability and reliability of the index under various weighting scenarios. Therefore, for the final analysis in this research, open-source software R 4.2.1 and Eviews1 have been utilized. This research indicates a significant relationship between the VIX fear index and the designed financial stress index. Additionally, the outcome of weighting the research variables using a hierarchical technique reveals that the gold price carries the highest weight of 0.369, followed by the U.S. Dollar index with 0.222 in the third place, the Euro to Dollar exchange rate with 0.174, and Brent crude oil index with 0.170, while the NASDAQ Composite index holds the fifth position with a weight of 0.065.

Keywords


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