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Reducing model risk in early warning systems for banking crises in the euro area

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  • Coudert, Virginie
  • Idier, Julien

Abstract

We aim at detecting periods preceding banking crises in the euro area through an early warning system (EWS) and propose a new method to deal with model uncertainty. In a first step, we select a set of macro-financial risk indicators for their signaling ability among a large number of candidates over the period spanning from 1985:q1 to 2009:q4. Then, we run all the possible logit models including four of these indicators as explanatory variables in order to assess the pre-crises probabilities at each time. We retain two sets of models: a small one only including models with all coefficients significant and with the expected signs, and a large set, obtained by relaxing the selection criteria. In a second step, we calculate the weighted average of the pre-crisis probabilities estimated by the models belonging to the two selected sets. The weight given to each model is proportional to its usefulness at identifying pre-crises periods either at the panel or the country-level. The simulations performed both over and out of sample show that aggregating more models yields better results than relying on any single model or only a few of them, as model uncertainty is reduced. Performance is also enhanced by aggregating models’ results with country-specific weights relatively to common panel-weightings.

Suggested Citation

  • Coudert, Virginie & Idier, Julien, 2018. "Reducing model risk in early warning systems for banking crises in the euro area," International Economics, Elsevier, vol. 156(C), pages 98-116.
  • Handle: RePEc:eee:inteco:v:156:y:2018:i:c:p:98-116
    DOI: 10.1016/j.inteco.2018.01.002
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    1. repec:bfr:bullbf:2019:222:01 is not listed on IDEAS
    2. repec:wsi:jicepx:v:09:y:2018:i:03:n:s1793993318500096 is not listed on IDEAS

    More about this item

    Keywords

    Macroprudential policy; Banking crises; Early warning indicators;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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