September 2022: BIS Quarterly Review – Under pressure: market conditions and stress

By Iñaki Aldasoro, Peter Hördahl and Sonya Zhu

When financial markets come under pressure, vital functions such as the efficient allocation of capital and price formation become impaired. It is therefore important to enhance the monitoring and analysis of market conditions, in particular events that may put pressure on authorities to intervene. We introduce market conditions indicators (MCIs) for each of three key market segments: the US Treasury and US money markets, and the foreign exchange market centred around the US dollar. Our daily MCIs reflect market volatility, illiquidity and deviations from standard no-arbitrage conditions. They capture well known episodes of market turmoil. We show that it is in some cases possible to identify conditions that point to a heightened risk of future market stress months ahead of the event.