An Empirical Research On Early-Warning Of Financial Risk In China

Since the1990s, financial crisis has happened more and more frequently. With the liberalization and marketization of global finance, the spread of the financial crisis speeds up, and the depth and breadth of the crisis expands. The European Debt Crisis presents a long-term trend and the slowdown of economic growth has spread worldwide. China’s financial reform begins to accelerate in2012. The representative events is that, in early June of this year the central bank cut interest rates while announced to open the floating range of deposit and lending rates slightly, which means banks will have greater freedom in terms of deposit and lending rates. The pace of market-oriented reforms of interest rates accelerates. In the corporate bond market, the approval process of bond issuance accelerates, and the issuance of more debts is encouraged. The bank asset securitization restarts and the scope of the asset securitization will gradually expand. In recent years, the controls on the capital account begin to relax. All these indicate that we are coming into the period of comprehensive financial reform.In the special period of the international financial risk increasing and the domestic financial reform accelerating, the research on early warning of financial risk is of great necessity. Timely and effective financial early warning can help to avoid or reduce the economic losses caused by financial crisis. In the domestic research, early warning systems are built mainly by integrating the indexes used in historical documents. So the indexes are usually lack of timeliness and pertinence. On the other hand, the degree of China’s financial marketization and financial innovation is not high, there is little risk of a crisis at home. But the effects of the international financial crisis can’t be ignored. However there’s little attention paid to the contagion effect of international financial crisis in domestic research. Based on the transmission channels of international financial crisis, this article builds China’s early warning system of financial risk. In the meantime, the current domestic financial risks and international potential financial risks are considered.Three questions are answered. In the context of the European debt crisis and domestic financial reform intertwined, in2012, what about China’s financial risk? What happened with China’s financial risk in more than a decade? Where are the risks from? Considering our actual financial condition, summarizing the limitations of the early-warning indicators from history literatures, we construct a real-time, targeted early-warning system with international perspectives starting with the transmission channels of the international financial crisis, as well as the background of the European debt crisis and the domestic financial reforms. Markov Regime-Switching model is used to describe the changes of financial risk of China in recent years. Finally, combining Markov model with ARMA model, the study forecasts the financial risk of China in the second half of2012. The result indicates that we are in low risk in the second half of2012, and the main sources of financial risk are from banking and stock market. The text is divided into six chapters:Chapter1is introduction. The background of the research and the significance of this topic are introduced. Some core concepts of this paper are defined, the main structure of the paper is given.Chapter2is literature review. The theories of financial crisis and some main early-warning models of financial crisis are reviewed. The methods of constructing early-warning system of financial crisis are summarized. In addition, some commentaries are given.Chapter3is the construction of early-warning system of international financial risk in China. In this chapter, the transmission channels of the international financial crisis are summarized and contagion mechanisms of different channels are analysis. The current potential financial risks from home and abroad, including risks posed by the European Debt Crisis and bank risk caused by financial reforms are analysis. Finally, based on the transmission channels of the international financial crisis, as well as the risk at home and abroad, an early-warning system of financial risk indicator is built.Chapter4is the construction and measure of financial pressure index. According to the IMF report—"World Economic Outlook Report2009", combined with the actual financial conditions of China, a financial stress index is compound from three levels, including the foreign exchange market, the banking sector and the stock market. The financial pressure over the past decade is estimated.Chapter5is the empirical research on early-warning of financial risk. After a brief introduction to Markov Regime-Switch model, a series of tests are made to the early-warning indicators. Using Markov Regime-Switch model, the changes of financial risk in our country are estimated. The values of early-warning indicators in the second half of2012are estimated through ARMA model. At last the financial situation under the second half of2012is predicted.Chapter6is conclusions and policy recommendations. The relevant conclusions of the empirical part are summarized, policy recommendations are put forward. The innovation and inadequacy of this paper are pointed out.The innovations of this research lie in two aspects. Firstly, the early-warning system of financial risk is build from the perspective of transmission channels of international financial crisis. It give Comprehensive consideration to the specific financial condition in China—the possibility of contagion from international financial risk is high; Secondly, considering current financial background—the unce(?)tainty of European debt crisis and the complexity of domestic financial reforms, early-warning indicators are with timeliness.There are also some deficiencies. The selection of indicators is more or less subjective. The shortage of some important variables and the method of filling the missing data may have effects on the final conclusions.