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

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Hali J. Edison

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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 analyzes 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 behavior 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.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 675.

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Date of creation: 2000
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Handle: RePEc:fip:fedgif:675

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Related research
Keywords: Financial crises ; Money;

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Aaron Tornell, 1999. "Common Fundamentals in the Tequila and Asian Crises," NBER Working Papers 7139, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. 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.). [Downloadable!]
  3. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises - The Early Warnings of Distress," IMF Working Papers 99/178, International Monetary Fund.
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  5. Graciela L. Kaminsky & Carmen M. Reinhart, 1996. "The twin crises: the causes of banking and balance-of-payments problems," International Finance Discussion Papers 544, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  6. 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. [Downloadable!] (restricted)
  7. Glick, Reuven & Rose, Andrew K., 1999. "Contagion and trade: Why are currency crises regional?," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 603-617, August. [Downloadable!] (restricted)
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  8. Kaminsky, Graciela & Lizondo, Saul & Reinhart, Carmen M., 1997. "Leading indicators of currency crises," Policy Research Working Paper Series 1852, The World Bank. [Downloadable!]
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  9. 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. [Downloadable!] (restricted)
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  10. Catherine A. Pattillo & Andrew Berg, 1998. "Are Currency Crises Predictable? A Test," IMF Working Papers 98/154, International Monetary Fund.
  11. Eduardo Borensztein & Gian Maria Milesi-Ferretti & Catherine A. Pattillo & Andrew Berg, 2000. "Anticipating Balance of Payments Crises--The Role of Early Warning Systems," IMF Occasional Papers 186, International Monetary Fund.
  12. 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. [Downloadable!] (restricted)
  13. 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. [Downloadable!]
  14. 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.). [Downloadable!]
  15. 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. [Downloadable!] (restricted)
  16. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1994. "Speculative Attacks on Pegged Exchange Rates: An Empirical Exploration with Special Reference to the European Monetary System," NBER Working Papers 4898, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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