Abstract
This paper attempts to develop a financial vulnerability indicator for China as a barometer for the state of financial vulnerability in the Chinese financial market, possibly for real-time application. Twelve variables from different sectors are utilised to extract a common vulnerability component using a dynamic approximate factor model. Through the implementation of a Markovswitching Bayesian vector autoregression (MSBVAR) model, the empirical results indicate that a high-vulnerability episode is associated with substantially lower economic activity, but a low-vulnerability episode does not incur substantial changes in economic activity. Notably, the constructed indicator can serve as a real-time early warning system to signify vulnerabilities in the Chinese financial market.
Highlights
Since 1995, economic development in China has been blessed with a remarkable acceleration of double-digit growth; except for the slowdown in 2014 due to the global economic meltdown, the average has been annual growth of 16 percent
The indicator construction through dynamic approximate factor model (DAFM) is calculated on a basis of 12 series of data from a mixture of financial market, property market and macroeconomic variables
Since the outbreak of the global financial crisis in 2008, monitoring the state of financial vulnerability has become a foremost concern for policy makers to provide a buffer for a macroprudential shock
Summary
Since 1995, economic development in China has been blessed with a remarkable acceleration of double-digit growth; except for the slowdown in 2014 due to the global economic meltdown, the average has been annual growth of 16 percent. Because of its evolution into an open economy, China was only marginally affected by the Asian financial crisis in 1997, the United States (US) dotcom bubble burst in 2001 and the hard hit from the subprime mortgage crisis in 2008. The sustainability of such rapid growth before the crisis was obstructed due to capital flight and the sudden collapse of external markets followed by the threat of deflationary pressure towards the end of 2008 (Yu, 2010). The Chinese economy sailed through the meltdown with its strong domestic consumption, in real estate investment
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