Measuring financial stress - a country specific stress index for Kenya

Abstract

The aftermath of the 2007-2008 global financial crisis shows how financial tum1oil can be transmitted from advanced to emerging and frontier markets. Most policy makers in emerging economies had little mechanisms to determine the status of their economies to implement the right policies to mitigate the risk of a crisis. This paper develops a financial stress index for the Kenyan financial sector which provides a continuous indication of stress in the financial sector. The index is based on four markets within the financial sector where stress could originate from. These are banking, fore if,'11 exchange, and bond and equity market. The paper uses variance equal weights to analyze the data from the various financial sectors. The data used was from February 2007 to November 2014. The research found that the financial stress index built in this research would be a useful tool for monitoring how financial markets were doing. This is because it captures systemic risk which is not easily observable from individual market indicators as is the case with the Kenyan financial sector.