Predicting Financial Crises: A Study of Asian Economies

Financial crises entail heavy adjustment costs on the global economy in the form of growth deceleration, weak external sector, rising prices and high unemployment. Moreover, the affected economies witness distressed policy reversals which sometimes prove detrimental to the home economy in high growth periods, typical of East Asian tigers during the 1997 financial crisis. These negative externalities inflicted upon the society in event of such crises warrant the need for credible effective crisis detection and monitoring mechanisms. This article contributes to that debate by identifying the presence of synchronicity and contagion risk in Asia in a panel cointegration model involving select financial sector variables. Empirical findings of the study interestingly reveal a strong existence of cointegration among these set of variables for the full period, that is, 1990: Q1 to 2011: Q2 as well as for various sub-periods suggesting high risk of contagion in the region. Further, the article presents a literature review on the role and effectiveness of early warning systems (EWSs) with a view to examine whether this synchronicity was adequately captured by those models or not. Regardless of the econometric techniques, the predictions of EWSs have rarely reflected the real crisis episodes.