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How to Evaluate an Early-Warning System: Toward a Unified Statistical Framework for Assessing Financial Crises Forecasting Methods

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Author Info

  • Bertrand Candelon
  • Elena-Ivona Dumitrescu
  • Christophe Hurlin

Abstract

This paper proposes an original and unified toolbox to evaluate financial crisis early-warning systems (EWS). It presents four main advantages. First, it is a model free method which can be used to assess the forecasts issued from different EWS (probit, logit, Markov switching models, or combinations of models). Second, this toolbox can be applied to any type of crisis EWS (currency, banking, sovereign debt, and so on). Third, it does not only provide various criteria to evaluate the (absolute) validity of EWS forecasts but also proposes some tests to compare the relative performance of alternative EWS. Fourth, this toolbox can be used to evaluate both in-sample and out-of-sample forecasts. Applied to a logit model for 12 emerging countries we show that the yield spread is a key variable for predicting currency crises exclusively for South-Asian countries. Besides, the optimal cut-off correctly allows us to identify now on average more than 2/3 of the crisis and calm periods.

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Bibliographic Info

Article provided by Palgrave Macmillan in its journal IMF Economic Review.

Volume (Year): 60 (2012)
Issue (Month): 1 (April)
Pages: 75-113

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Handle: RePEc:pal:imfecr:v:60:y:2012:i:1:p:75-113

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Cited by:
  1. Sarlin, Peter, 2013. "On policymakers’ loss functions and the evaluation of early warning systems," Economics Letters, Elsevier, vol. 119(1), pages 1-7.
  2. Fabio Comelli, 2013. "Comparing Parametric and Non-parametric Early Warning Systems for Currency Crises in Emerging Market Economies," IMF Working Papers 13/134, International Monetary Fund.
  3. Qin, Xiao & Liu, Liya, 2014. "Extremes, return level and identification of currency crises," Economic Modelling, Elsevier, vol. 37(C), pages 439-450.

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