Co-movement of Banking Stress Across Emerging and Developed Economies: A Dynamic Factor Model and Wavelet Coherence Approach

Abstract

This study develops a robust banking stability indicator for emerging and advanced economies and examines the linkage of banking stress across economies. We contribute by including interbank borrowings and banking sector volatility to measure contagious risk besides the traditional variables. Second, we use aggregate banking sector data for five countries (China, India, Japan, the UK and the USA) from 1998 to 2015 and employ dynamic factor model to develop the index. Results show higher stress levels in the UK and China, and all economies witness increased stress during the 2007–2009 crises, but the recovery phase varies. Finally, we use wavelet coherence analysis and find evidence of stress transmission from emerging economies to other emerging and advanced economies.