A Measure of Downside Risk in Multivariate Setup with Application in Measuring Financial Stress

Financial Stress Indicator (FSI) combines indicators from different segments of the financial market into a unified measure, which indicates the current degree of stress in the financial system. Existing methods for combining various indicators/variables have some limitations - either correlation between the variables is not factored or sometimes interpretation of their coefficients becomes difficult. We propose an alternative method for FSI by developing a multivariate downside risk measure that combines the concepts of multivariate distance and semivariance. We compare performance of this method alongside the existing methods by applying them to United States and Indian data and find that the proposed method is able to identify financial stress in these markets reasonably well.