New study: Measuring Stress and Risks to the Financial System in Israel on a Radar Chart
- New research presents a method to construct and to display composite indicators representing both risks originating in the financial system in Israel and risks originating abroad.
- The research took six composite indicators which, in the researcher's assessment, represent the various factors which impact on the financial system in Israel. In order to conveniently display all six indicators together, a diagram known as a radar chart is used.
- The study's findings indicate that the method successfully captures the dynamics of financial stress in Israel, and its development since 1998.
The accepted tools for identifying financial stress focus on various components of financial system. Thus, they may, at times, fail to present the overall picture. The financial crisis which broke out in 2008 emphasized the need to improve the measures and indicators of financial stress, and the manner in which they are combined to present an overall view. These indicators can help to identify vulnerabilities and imbalances in Israel's financial system, which are liable to threaten the system's stability.
New research by Hanan Zalkinder of the Bank of Israel Research Department adopts an intuitive method to present the mass of data related to financial stress, and applied it to Israel. In the first stage, the research presents a method to construct indicators which present both risks originating in the financial system in Israel and risks originating outside the system. It is important to note that the indicators are not intended to forecast future developments in the financial system, but to examine its state at the time of measurement. The research assumes that accurate measurement of the present state of the system will enable policy makers to better assess possible future developments and reach appropriate decisions.
The research took six composite indicators which, in the researcher's estimation, represent the various aspects of the financial system in Israel. In order to conveniently display the various indicators, the researcher uses a diagram known as a radar chart, a multidimensional illustration which combines the presentation of several indicators and enables their comparison at different points in time. This method of presentation is an intuitive starting point for discussion, and can aid policy makers to better assess the state of Israel's financial system.
The study's findings indicate that the method successfully captures the dynamics of financial stress and its development since 1998. The paper presents the results for various periods, such as the financial crisis in Russia and the collapse of the LTCM hedge fund, the Second Lebanon War, and the recent financial crisis. In order to strengthen the findings, the researcher conducted out-of-sample tests, and shows that the method's efficiency is greater than the observations used in its development, and independent of them.
The illustration below shows how the system locates the increase in financial stress in all the components during the period before the height of the crisis in the fourth quarter of 2008.