Title: Dissecting the financial cycle with dynamic factor models
Authors: Christian Menden - University of Bamberg (Germany) [presenting]
Christian Proano - University of Bamberg (Germany)
Abstract: The analysis of the financial cycle has become a central topic since the 2007-08 financial crisis. So far, the great majority of studies has analyzed the cyclical properties of the financial cycle by means of a small number of financial risk indicators at a rather aggregated level. An empirical approach is proposed to extract information about the financial cycle from a large data set of macroeconomic and financial variables for the US. Using a dynamic factor model we estimate three synthetic financial cycle components that account for the majority of the variation in the complete data set. Peaks in our synthetic financial cycle components coincide with economic recessions giving rise to potential properties as early warning indicators for financial and economic distress. Thus, we investigate whether our financial cycle components have significant predictive power for GDP growth, output gap, inflation and short-term interest rates by means of Granger causality tests. Further, we analyze the forecasting power of recessions by estimating the recession probabilities based on a probit approach.