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The Financial Stress Index: Identification of Systemic Risk Conditions

Advisory: This article is based in whole or in part on the CFSI (Cleveland Financial Stress Indicator), an indicator that was discontinued by the Federal Reserve Bank of Cleveland in 2016 due to the discovery of errors in the indicator’s construction. These errors overestimated stress in the real estate and securitization markets. As a result, readers should be cautious and interpret any analysis based on CFSI data with those errors in mind.

This paper develops a financial stress index for the United States, the Cleveland Financial Stress Index (CFSI), which provides a continuous signal of financial stress and broad coverage of the areas that could indicate it. The index is based on daily public-market data collected from four sectors of the financial markets—the credit, foreign exchange, equity, and interbank markets. A dynamic weighting method is employed to capture changes in the relative importance of these four sectors as they occur. In addition, the design of the index allows the origin of the stress to be identified. We compare the CFSI to alternative indexes, using a detailed benchmarking methodology, and show how the CFSI can be applied to systemic stress monitoring and early warning system design. To that end, we investigate alternative stress-signaling thresholds and frequency regimes and then establish optimal frequencies for filtering out market noise and idiosyncratic episodes. Finally, we quantify a powerful CFSI-based rating system that assigns a probability of systemic stress to ranges of CFSI outcomes.

JEL classification: G01, C22, C25, C52, C53, E32, E37

Keywords: Systemic risk; financial stress; financial stress index; early warning system

Suggested citation: Oet, Mikhail V., Ryan Eiben, Timothy Bianco, Dieter Gramlich, and Stephen J. Ong, 2011. “The Financial Stress Index: Identification of Systemic Risk Conditions,” Federal Reserve Bank of Cleveland, Working Paper no. 11-30R3.

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