Regime-switching measure of systemic financial stress

In this paper, I propose an approach to measuring systemic financial stress. In particular, abrupt and large changes in the volatility of financial variables that represent the dynamics of the US financial sector are modeled with a joint regime-switching process, distinguishing “low” and “high” volatility regimes. I find that the joint “high” volatility regime for the TED spread, return on the NYSE index, and capital-weighted CDS spread for large banks is closely related to periods of financial stress. This result suggests that the probability of the joint high volatility regime of these financial variables can be considered as a measure of systemic financial stress. Copyright Springer-Verlag 2013