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The U.S financial crises of 2008 highlighted the role of a depressed financial system in causing an economic downturn. This pioneer empirical study develops a financial stress index for the Pakistan economy during 2000-2013. We use key variables that capture unique aspect of stress in the financial system. Principal component analysis technique is used to aggregate the components to a single index. Empirical analysis reveals that banking sector and stock market volatility are the leading contributors to financial stress in Pakistan. The developed financial stress index is then used to trace high episodes of financial stress. Our index was successful in identifying three main financial crises that attacked the financial system including global financial crisis of 2008. Afterwards, the impact of financial stress on real economic activity is examined using impulse response function and Granger causality analysis. We find the expected results as high values of financial stress index are associated with decline in macroeconomic indicators. These findings will provide useful information to readers about the financial and economic dynamics of a developing economy like Pakistan.
About the author
Ahsan Akbar is currently pursuing his PhD in Financial Management from Zhongnan University of Economics and Law, Wuhan, China. He holds a permanent faculty position at Department of Management Sciences, University of Education Lahore, Pakistan.His research interests include analysis of financial systems, Corporate finance, and Islamic finance.
