Constructing a dynamic financial conditions indexes by TVP-FAVAR model

ABSTRACT

A factor augmented vector autoregressive models with time-varying coefficients and stochastic volatility is used to constructing financial conditions index to explore the link between composite index of financial indicators and future inflation. Time variation in the models’ parameters allows for the weights attached to each financial variable in the index to evolve over time. A monthly data of Chinese CPI and a wide range of macroeconomic variables are adopted to construct FCI and the experiment result shows its good forecasting performance to inflation.

KEYWORDS:

• Financial conditions index
• CPI inflation
• TVP-FAVAR

JEL CLASSIFICATION:

• C32
• E27

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the National Natural Science Foundation of China [71671070].