Detecting and interpreting financial stress in the euro area

There is a need to find better models and indicators for large disruptive events, not least in order to be more prepared and mitigate their effects. In this paper we take a step in this direction and discuss the performance of a financial stress indicator with a specific focus on the euro area. As far as we know, our indicator is the first attempt to develop an indicator of financial stress with a specific focus on the euro area. It is also the first to exploit the information contained in central bank communication to help measure stress in financial markets. For use in real time, the indicator is able to efficiently extract information from an otherwise noisy signal and provide information about the level of stress in the markets. JEL Classification: E44, E50, G10behavioural finance, central bank communication, Financial stress, Leading Indicator, logit distribution

Up for count? Central bank words and financial stress

While knowing there is a financial distress 'when you see it' might be true, it is not particularly helpful. Indeed, central banks have an interest in understanding more systematically how their communication affects the markets, not least in order to avoid unnecessary volatility; the markets for their part have an interest in better deciphering the message of central banks, especially of course with regard to the conduct of future monetary policy. In this paper we use a novel approach rooted in textual analysis to begin to address these issues. Building on previous work from textual analysis, we are able to use quantitative methods to help identify and measure financial stress. We apply the techniques to the European Central Banks Monthly Bulletin and show that the results give a much more complete and nuanced picture of market distress than those based only on market data and may help improve how the Central Banks communication is designed and understood.Financial stress; central bank communication; textual analysis; logit distribution