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On policymakers’ loss functions and the evaluation of early warning systems: Comment

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  • Alessi, Lucia
  • Detken, Carsten

Abstract

Sarlin (2013) suggests that if a loss function approach is chosen to derive the optimal threshold for financial crisis early warning indicators, the loss function specification should explicitly take into account the unconditional sample crisis probability. In this comment we argue that this approach is not robust to small perturbations of the preference parameter and is not easy to use for policy purposes. We suggest therefore to continue using a simpler loss function specification.

Suggested Citation

  • Alessi, Lucia & Detken, Carsten, 2014. "On policymakers’ loss functions and the evaluation of early warning systems: Comment," Economics Letters, Elsevier, vol. 124(3), pages 338-340.
    • Handle: RePEc:eee:ecolet:v:124:y:2014:i:3:p:338-340
    DOI: 10.1016/j.econlet.2014.06.015
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    References listed on IDEAS

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    1. Drehmann, Mathias & Juselius, Mikael, 2014. "Evaluating early warning indicators of banking crises: Satisfying policy requirements," International Journal of Forecasting, Elsevier, vol. 30(3), pages 759-780.
    2. Sarlin, Peter, 2013. "On policymakers’ loss functions and the evaluation of early warning systems," Economics Letters, Elsevier, vol. 119(1), pages 1-7.
    3. Alessi, Lucia & Detken, Carsten, 2011. "Quasi real time early warning indicators for costly asset price boom/bust cycles: A role for global liquidity," European Journal of Political Economy, Elsevier, vol. 27(3), pages 520-533, September.
    4. Bussiere, Matthieu & Fratzscher, Marcel, 2008. "Low probability, high impact: Policy making and extreme events," Journal of Policy Modeling, Elsevier, vol. 30(1), pages 111-121.
    5. Mr. Andrew Berg & Mr. Enrico G Berkes & Ms. Catherine A Pattillo & Mr. Andrea F Presbitero & Mr. Yorbol Yakhshilikov, 2014. "Assessing Bias and Accuracy in the World Bank-IMF's Debt Sustainability Framework for Low-Income Countries," IMF Working Papers 2014/048, International Monetary Fund.
    6. Demirguc, Asli & Detragiache, Enrica, 2000. "Monitoring Banking Sector Fragility: A Multivariate Logit Approach," The World Bank Economic Review, World Bank, vol. 14(2), pages 287-307, May.
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    Cited by:

    1. Shen-Tsu Wang, 2016. "An Exploration of Sustainable Customer Value and the Procedure of the Intelligent Digital Content Analysis Platform for Big Data Using Dynamic Decision Making," Asian Journal of Economics and Empirical Research, Asian Online Journal Publishing Group, vol. 3(1), pages 25-31.
    2. Oet, Mikhail V. & Gramlich, Dieter & Sarlin, Peter, 2016. "Evaluating measures of adverse financial conditions," Journal of Financial Stability, Elsevier, vol. 27(C), pages 234-249.
    3. Theshne Kisten, 2019. "A financial stress index for South Africa: A time-varying correlation approach," Working Papers 805, Economic Research Southern Africa.
    4. Alessi, Lucia & Balduzzi, Pierluigi & Savona, Roberto, 2019. "Anatomy of a Sovereign Debt Crisis: CDS Spreads and Real-Time Macroeconomic Data," Working Papers 2019-03, Joint Research Centre, European Commission.
    5. Maria Siranova & Marek Radvanský, 2018. "Performance of the Macroeconomic Imbalance Procedure in light of historical experience in the CEE region," Journal of Economic Policy Reform, Taylor & Francis Journals, vol. 21(4), pages 335-352, October.
    6. Diptes C. P. Bhimjee, 2022. "Adaptive Early Warning Systems: An Axiomatic Approach," Journal of Central Banking Theory and Practice, Central bank of Montenegro, vol. 11(2), pages 145-164.
    7. Sondermann, David & Zorell, Nico, 2019. "A macroeconomic vulnerability model for the euro area," Working Paper Series 2306, European Central Bank.
    8. Duprey, Thibaut & Klaus, Benjamin, 2022. "Early warning or too late? A (pseudo-)real-time identification of leading indicators of financial stress," Journal of Banking & Finance, Elsevier, vol. 138(C).

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    More about this item

    Keywords

    Early warning systems; Policymakers’ preferences; Policymakers’ loss function;
    All these keywords.

    JEL classification:

    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • G01 - Financial Economics - - General - - - Financial Crises

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