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Do indicators of financial crises work? An evaluation of an early warning system

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  • Hali J. Edison

    (Research Department, International Monetary Fund, USA)

Abstract

The object of this paper is to develop an operational early warning system (EWS) that can detect financial crises. To achieve this goal the paper analyses and extends the early warning system developed by Kaminsky, Lizondo and Reinhart (1998) and Kaminsky and Reinhart (1999) that is based on the 'signal' approach. This system monitors several indicators that tend to exhibit an unusual behaviour in the periods preceding a crisis. When an indicator exceeds (or falls below) a threshold, then it is said to issue a 'signal' that a currency crisis may occur within a given period. The model does a fairly good job of anticipating some of the crises in 1997|1998, but several weaknesses to the approach are identified. The paper also evaluates how this system can be applied to an individual country. On balance, the results in this paper are mixed, but the results suggest that an early warning system should be thought of as a useful diagnostic tool. Copyright © 2002 John Wiley & Sons, Ltd.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal International Journal of Finance & Economics.

Volume (Year): 8 (2003)
Issue (Month): 1 ()
Pages: 11-53

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Handle: RePEc:ijf:ijfiec:v:8:y:2003:i:1:p:11-53

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  1. Kamin, Steven B., 1999. "The current international financial crisis:: how much is new?," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 501-514, August.
  2. Berg, Andrew & Pattillo, Catherine, 1999. "Predicting currency crises:: The indicators approach and an alternative," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 561-586, August.
  3. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  4. Catherine A. Pattillo & Andrew Berg, 1998. "Are Currency Crises Predictable? a Test," IMF Working Papers 98/154, International Monetary Fund.
  5. Glick, Reuven & Rose, Andrew K, 1998. "Contagion and Trade: Why are Currency Crises Regional," CEPR Discussion Papers 1947, C.E.P.R. Discussion Papers.
  6. Catherine A. Pattillo & Andrew Berg & Gian-Maria Milesi-Ferretti & Eduardo Borensztein, 2000. "Anticipating Balance of Payments Crises," IMF Occasional Papers 186, International Monetary Fund.
  7. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1995. "Speculative attacks on pegged exchange rates: an empirical exploration with special reference to the European Monetary System," Working Papers in Applied Economic Theory 95-04, Federal Reserve Bank of San Francisco.
  8. Steven B. Kamin & Oliver D. Babson, 1999. "The contributions of domestic and external factors to Latin American devaluation crises: an early warning systems approach," International Finance Discussion Papers 645, Board of Governors of the Federal Reserve System (U.S.).
  9. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
  10. Aaron Tornell, 1999. "Common Fundamentals in the Tequila and Asian Crises," Harvard Institute of Economic Research Working Papers 1868, Harvard - Institute of Economic Research.
  11. Eichengreen, Barry & Rose, Andrew K & Wyplosz, Charles, 1996. "Contagious Currency Crises," CEPR Discussion Papers 1453, C.E.P.R. Discussion Papers.
  12. Frankel, Jeffrey A. & Rose, Andrew K., 1996. "Currency crashes in emerging markets: An empirical treatment," Journal of International Economics, Elsevier, vol. 41(3-4), pages 351-366, November.
  13. Steven B. Kamin, 1999. "The current international financial crisis: how much is new?," International Finance Discussion Papers 636, Board of Governors of the Federal Reserve System (U.S.).
  14. Girton, Lance & Roper, Don, 1977. "A Monetary Model of Exchange Market Pressure Applied to the Postwar Canadian Experience," American Economic Review, American Economic Association, vol. 67(4), pages 537-48, September.
  15. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises," IMF Working Papers 99/178, International Monetary Fund.
  16. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany.
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