The Signals Approach as an Early Warning System for Currency Crises. An Application to Transition Economies - with special emphasis on Poland

Objectives: The objectives of this empirical study are: firstly, to modify and extend the 'signals approach', developed by Kaminsky/Lizondo/Reinhart (1997) as an early warning system for currency crises, secondly, to apply it to transition economies in Central and Eastern Europe, and, thirdly, to calculate and measure the risk potential of currency crises in those countries. Results: The results show that the currency crises included in this study can be explained ex-post us-ing the 'signals approach'. Although differences in individual crises remain, they have nonetheless much in common with currency crises in other emerging markets. The modified 'signals approach' seems to have enough explanatory power to assess the current vulnerability to currency crises in this country sample. Both the composite indicator and statistics based on it give a reasonably clear picture of the risk of currency crises. For instance, even though the indicators were calculated based on the sample of crises countries, which does not include Poland, the composite index and the conditional probabilities of currency crises show a high risk for this economy throughout the year 2001. Looking at the situation in November 2001 the highest vulnerability can be found in the three largest new EU-member states and future participants in the EMS/EMU (Hungary, Czech Republic, and Poland). Conclusion: The results of this study show that the 'signals approach' is useful both for assessing a coun-try's risk potential and for a structured ex-post analysis. Even for non-market economies such as Moldova and Belarus statistically reasonable results can be obtained. However, one cannot realistically expect to derive detailed information on the occurrence and impacts of crises from this study.