A new index of financial conditions

We use factor augmented vector autoregressive models with time-varying coe¢ cients to construct a …nancial conditions index. The time-variation in the parameters allows for the weights attached to each …nancial variable in the index to evolve over time. Furthermore, we develop methods for dynamic model averaging or selection which allow the …nancial variables entering into the FCI to change over time. We discuss why such extensions of the existing literature are important and show them to be so in an empirical application involving a wide range of …nancial variables.