Building a financial conditionsiIndex for Turkey

Abstract

The rapid expansion of financial markets in the last decades has increased the role of financial markets on economic activities. Given that most of macroeconomic models which only include interest rate and exchange rate have very little financial integration, there is a need to develop a comprehensive model that captures the financial conditions in Turkey. This study uses factor model to construct a financial conditions index out of wide range of financial variables from the beginning of 2007 to the end of 2017. Financial conditions index is basically weighted average of various financial variables. The weights found using factor model suggest that the exchange rate, stock market and real corporate credit interest rate mainly derive the financial conditions whereas the contribution of money supply, interest rate spread and real consumer loans to financial conditions is very little in Turkey. Moreover, the relationship between FCI and economic activity is investigated with nonlinear autoregressive distributed lags model. The results suggest that assymetric effects of FCI exist and positive shocks impact economic activity more than negative shocks. The constructed FCI in this study and its proven strong role on real economy in T k . ve the research which aims to capture financial conditions and ur ey can Irnpro • t:t' • ss of financial policies implemented by Central Bank of the Improve euecuvene Republic of Turkey.