  Tracking the build-up of financial vulnerabilities is a key component of
financial stability policy. Due to the complexity of the financial system, this
task is daunting, and there have been several proposals on how to manage this
goal. One way to do this is by the creation of indices that act as a signal for
the policy maker. While factor modelling in finance and economics has a rich
history, most of the applications tend to focus on stationary factors.
Nevertheless, financial stress (and in particular tail events) can exhibit a
high degree of inertia. This paper advocates moving away from the stationary
paradigm and instead proposes non-stationary factor models as measures of
financial stress. Key advantage of a non-stationary factor model is that while
some popular measures of financial stress describe the variance-covariance
structure of the financial stress indicators, the new index can capture the
tails of the distribution. To showcase this, we use the obtained factors as
variables in a growth-at-risk exercise. This paper offers an overview of how to
construct non-stationary dynamic factors of financial stress using the UK
financial market as an example.
