Measuring financial systemic stress for Turkey: A search for the best composite indicator

In this study, we aim to construct a single financial stress indicator (FSI) for Turkey adopting weekly data from between April 2005 and December 2016. To do so, we compose 15 different FSIs using 14 variables that will represent five different markets, i.e. the money market, the bond market, the foreign exchange market, the equity market and the banking sector. We aggregate these five different markets using a variety of techniques, including principal component analysis (PCA), basic portfolio theory, variance equal weights and the Bayesian dynamic factor model. We compare 15 different FSIs on the basis of their relation to, and the forecasting power of, different variables such as the growth rate of industrial production, the OECD business condition index and the OECD composite leading indicator for Turkey. Our results suggest that there is no simple best indicator for Turkey to measure financial systemic stress. Some indicators offer good forecasting power for economic growth while others have a stronger correlation with systemic risk. Therefore, we offer a final FSI for Turkey conducting a model averaging method via a rolling correlation based weighting scheme to benefit from the information content of all the FSIs and observe that the final FSI successfully indicates the tension periods.