Cleveland Fed’s Systemic Risk Indicator is Reliable, Timely, and Valid When Predicting Stress
The Cleveland Fed’s systemic risk indicator (SRI) was developed in response to the financial crisis of 2007-2009 in the hope that it could provide regulators with advance warning of conditions that might warrant a corrective response.
In this Economic Commentary, Cleveland Fed researcher Ben Craig provides a review of the SRI’s performance from 2001 to 2020, a period that predates and includes the financial crisis, to see how well it signaled times of known stress.
“I find that the index is reliable, timely, and valid,” says Craig. “It signaled each of the stressful periods that occurred over the period, and provided good ongoing information during the financial crisis.”
The reason that the SRI works well is that it combines measures of balance-sheet strength, volatility, and correlation of the asset values of the major banks with the forward-looking characteristics of option prices.
The Cleveland Fed’s systemic risk indicator can be computed daily and has the additional advantage of being relatively free of false positives, where an indicator can predict stress that is not there.
Federal Reserve Bank of Cleveland
The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the nation’s central bank, the Cleveland Fed participates in the formulation of US monetary policy, supervises banking organizations, provides payment and other services to financial institutions and the US Treasury, and performs many activities that support Federal Reserve operations Systemwide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and education activities.
The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia. For more information, go to www.ClevelandFed.org or follow us on Facebook, Twitter, Instagram or LinkedIn.