Iranian Economic Review

Iranian Economic Review

Constructing the Financial Conditions Index for Iran's Economy and Assessing its Effects on Stock Returns by FAVAR and TVP-FAVAR Models

Articles in Press

Document Type : Research Paper

Authors
Samere Raki Kianpour
Seyed Aziz Arman
Hassan Farazmand
Department of Economics, Faculty of Economics and Social Sciences, Shahid Chamran University of Ahvaz, Ahvaz, Iran
10.22059/ier.2024.371620.1007923
Abstract
In this study, the financial conditions index (FCI) for Iran's economy was reviewed. The factor-augmented vector autoregressive model and the factor-augmented vector autoregressive model with time-varying coefficients are used to construct FCI. The ability of the constructed index to predict various variables is also evaluated. The construction of the index and estimation of the models are based on the quarterly data for the period 1989 to 2019. The variables used included interest rate and inflation, exchange rate, consumption, banking facility, total stock market index, money supply, oil revenue, and GDP growth. The findings indicated significant volatilities in the model parameters. According to the findings, Under the restriction that model parameters are time-invariant, the shock from the improvement of the financial conditions index led to a negative response to the stock market index and this effect remained for eight periods; However, with time-varying coefficients, the stock market index has responded positively to shock in FCI, and this effect remained for 10 periods and then disappeared. Furthermore, according to the results of the In-sample prediction error, the Root Mean Square Error (RMSE) represents the high power of model prediction.
Keywords
Financial Condition Index
Stock Returns
Factor Augmented Vector Autoregressive Model
Time-Varying Parameter Model
Iran
Subjects
Iranian Economic Review

Articles in Press, Accepted Manuscript
Available Online from 19 May 2024