BofA Merrill Lynch Global Research has introduced the Global Financial Stress Index (GFSI), a cross-market gauge of risk, hedging demand and investment flows. The index is designed to help investors identify market risks earlier and more accurately than commonly used risk indicators, such as the VIX index.
The GFSI composite index aggregates over 20 measures of stress across five asset classes and various geographies, measuring three separate kinds of financial market stress: risk, as indicated by cross-asset measures of volatility, solvency and liquidity; hedging demand, implied by the skew of equity and currency options; and investor appetite for risk, as measured by trading volumes as well as flows in and out of equities, high-yield bonds and money markets.
Back-testing of the GFSI since 2000 illustrates that sharp rises in the index over short periods of time would have had a high degree of accuracy in forecasting sell-offs in assets, particularly global equities, commodities and US high-yield bonds.
“Since the global financial crisis, risk appears to have become as important to investors as return,” said Michael Hartnett, chief global equity strategist at BofA Merrill Lynch Global Research. “The GFSI measures risks not normally visible in public markets by incorporating assets trading in the over-the-counter market. We believe its breadth and depth make it a better measure of financial market stress than the VIX, which is based on US options data alone.”
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