Measuring and Testing a Modified Version of the South African Financial Cycle

Working Paper 869

Abstract

This study reports on measuring and testing of a Composite Financial Cycle Index (CFCI) as a modified version of a South African Financial Cycle (FC). This is achieved through the adoption of thirteen monthly financial time series indicators observed over the period 2000M1 to 2018M12. In this context, a Two-Step Markov Switching Dynamic Factor in State-Space Form is utilised. The analyses are extended through the measurement of the SARB proxy index in order to facilitate comparison.  The study provided evidence that the indicators of credit, house price and equity prices are the best indicators for measuring FCs in South Africa. However, there exist room for extension of the scope of financial time series variables used beyond these indicators. The added indicators proved to have more information content for financial crises forecasting. They have further proved to be better signals and to be better early warning indicators of financial crises in South Africa. Therefore, the addition of time series indicators beyond credit, house price and equity, increased the accuracy in measuring FCs, which could help prevent vulnerabilities from accumulating unnoticed.