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How to evaluate an Early Warning System ?

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Author Info

  • Bertrand Candelon

    (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)

  • Elena-Ivona Dumitrescu

    ()
    (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)

  • Christophe Hurlin

    ()
    (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)

Abstract

This paper proposes an original and uni ed toolbox to evaluate nancial crisis Early Warning Systems (EWS). It presents four main advantages. First, it is a model free method which can be used to asses the forecasts issued from di erent 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, etc.). 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, our toolbox can be used to evaluate both in-sample and out-of-sample forecasts. Applied to a logit model for twelve emerging countries we show that the yield spread is a key variable to predict currency crises exclusively for South-Asian countries. Besides, the optimal cut-o correctly allows us to identify now on average more than 2/3 of the crisis and calm periods.

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File URL: http://halshs.archives-ouvertes.fr/docs/00/67/38/85/PDF/EWSEval22_09_2011FIN.pdf
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Bibliographic Info

Paper provided by HAL in its series Working Papers with number halshs-00450050.

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Date of creation: 01 Jan 2012
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Handle: RePEc:hal:wpaper:halshs-00450050

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Related research

Keywords: currency crisis; Early Warning System; credit-scoring;

References

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  1. Reinhart, Carmen & Kaminsky, Graciela, 1998. "Financial crises in Asia and Latin America: Then and now," MPRA Paper 13877, University Library of Munich, Germany.
  2. Hali J. Edison, 2000. "Do indicators of financial crises work? an evaluation of an early warning system," International Finance Discussion Papers 675, Board of Governors of the Federal Reserve System (U.S.).
  3. Kaminsky, Graciela L. & Schmukler, Sergio L., 1999. "What triggers market jitters?: A chronicle of the Asian crisis," Journal of International Money and Finance, Elsevier, vol. 18(4), pages 537-560, August.
  4. Laurent E. Calvet, 2004. "How to Forecast Long-Run Volatility: Regime Switching and the Estimation of Multifractal Processes," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 2(1), pages 49-83.
  5. 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.
  6. Susmel, Raul, 2000. "Switching Volatility in Private International Equity Markets," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(4), pages 265-83, October.
  7. Aaron Tornell, 1999. "Common Fundamentals in the Tequila and Asian Crises," Harvard Institute of Economic Research Working Papers 1868, Harvard - Institute of Economic Research.
  8. Giancarlo Corsetti & Paolo Pesenti & Nouriel Roubini, 1998. "Paper Tigers? A Model of the Asian Crisis," NBER Working Papers 6783, National Bureau of Economic Research, Inc.
  9. Bussière, Matthieu & Fratzscher, Marcel, 2002. "Towards a new early warning system of financial crises," Working Paper Series 0145, European Central Bank.
  10. Morris Goldstein & Carmen M. Reinhart, 2000. "Assessing Financial Vulnerability: An Early Warning System for Emerging Markets," Peterson Institute Press: All Books, Peterson Institute for International Economics, number 100, July.
  11. Graciela Laura Kaminsky, 1997. "Leading Indicators of Currency Crises," IMF Working Papers 97/79, International Monetary Fund.
  12. Carmen M. Reinhart & Graciela L. Kaminsky, 1999. "The Twin Crises: The Causes of Banking and Balance-of-Payments Problems," American Economic Review, American Economic Association, vol. 89(3), pages 473-500, June.
  13. Eichengreen, Barry & Rose, Andrew K & Wyplosz, Charles, 1996. "Contagious Currency Crises," CEPR Discussion Papers 1453, C.E.P.R. Discussion Papers.
  14. Parkinson, Michael, 1980. "The Extreme Value Method for Estimating the Variance of the Rate of Return," The Journal of Business, University of Chicago Press, vol. 53(1), pages 61-65, January.
  15. Chou, Ray Yeutien, 2005. "Forecasting Financial Volatilities with Extreme Values: The Conditional Autoregressive Range (CARR) Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 561-82, June.
  16. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333.
  17. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, vol. 42(1), pages 27-62, September.
  18. Franc Klaassen, 2002. "Improving GARCH volatility forecasts with regime-switching GARCH," Empirical Economics, Springer, vol. 27(2), pages 363-394.
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Citations

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Cited by:
  1. Francine Gresnigt & Erik Kole & Philip Hans Franses, 2014. "Interpreting Financial Market Crashes as Earthquakes: A New early Warning System for Medium Term Crashes," Tinbergen Institute Discussion Papers 14-067/III, Tinbergen Institute.
  2. Fabio Comelli, 2012. "Emerging Market Sovereign Bond Spreads," IMF Working Papers 12/212, International Monetary Fund.
  3. Bertrand Candelon & Jameel Ahmed & Stefan Straetmans, 2014. "Predicting and Capitalizing on Stock Market Bears in the U.S," Working Papers 2014-409, Department of Research, Ipag Business School.
  4. Janus, Thorsten & Riera-Crichton, Daniel, 2013. "International gross capital flows: New uses of balance of payments data and application to financial crises," Journal of Policy Modeling, Elsevier, vol. 35(1), pages 16-28.
  5. Elena-Ivona Dumitrescu & Bertrand Candelon & Christophe Hurlin & Franz C. Palm, 2012. "Multivariate Dynamic Probit Models: An Application to Financial Crises Mutation," Working Papers halshs-00630036, HAL.
  6. Xavier De Scheemaekere & Kim Oosterlinck & Ariane Szafarz, 2012. "Addressing Economic Crises: The Reference-Class Problem," Working Papers CEB 12-024, ULB -- Universite Libre de Bruxelles.
  7. Candelon Bertrand & Dumitrescu Elena-Ivona & Hurlin Christophe, 2010. "Currency Crises Early Warning Systems: why they should be Dynamic," Research Memorandum 047, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  8. Gabriela Dobrescu & Iva Petrova & Nazim Belhocine & Emanuele Baldacci, 2011. "Assessing Fiscal Stress," IMF Working Papers 11/100, International Monetary Fund.
  9. Adrian Pagan & Don Harding, 2011. "Econometric Analysis and Prediction of Recurrent Events," NCER Working Paper Series 75, National Centre for Econometric Research.

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