Financial stress dynamics in China: An interconnectedness perspective

Since the subprime crisis, financial stress has been subjected to increased attention. However, related research of emerging economics is still in its infancy. Considering that the financial market is quite interconnected due to its complexity, we measure the stress dynamics of the Chinese financial market from an interconnectedness perspective. Multiple manifestations of interconnectedness are first investigated in this paper. It is found that the interbank and bond market are highly connected and play a central role in stress transmission. Then, financial stress is measured with the consideration of the interconnectedness. Finally, the asymmetric and nonlinear economic effects of financial stress are investigated, and thresholds are determined to distinguish between periods of financial stress and normal periods. The Financial Stress Index constructed in this paper effectively captures real-time status and identifies stressed periods, thus contributing to the early warnings and subsequent risk management in China. A systemic but focused strategy is suggested to deal with financial stress.