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Toward an early warning system of financial crises: What can index futures and options tell us?

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  • Li, Wei-Xuan
  • Chen, Clara Chia-Sheng
  • French, Joseph J.

Abstract

This research develops an early warning system (EWS) for equity market crises based on multinomial logit models and variables relating to the information content of index futures and option markets. We show that the information impounded in S&P 500 futures and options is useful as leading indicators of financial crises. Results reveal that models estimated with futures and put options significantly improve the medium-term predictability of equity market crises. Variables that consistently provided information of an impending crisis include: the VIX, open interest, dollar volume, put option price, put option effective spread, and the Treasury term spread.

Suggested Citation

  • Li, Wei-Xuan & Chen, Clara Chia-Sheng & French, Joseph J., 2015. "Toward an early warning system of financial crises: What can index futures and options tell us?," The Quarterly Review of Economics and Finance, Elsevier, vol. 55(C), pages 87-99.
    • Handle: RePEc:eee:quaeco:v:55:y:2015:i:c:p:87-99
    DOI: 10.1016/j.qref.2014.07.004
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    6. Matkovskyy, Roman & Bouraoui, Taoufik & Hammami, Helmi, 2015. "Estimation and prediction of an Index of Financial Safety of Tunisia," MPRA Paper 74573, University Library of Munich, Germany, revised 2016.
    7. Hossein Dastkhan, 2021. "Network‐based early warning system to predict financial crisis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(1), pages 594-616, January.
    8. Kouaissah, Noureddine, 2021. "Using multivariate stochastic dominance to enhance portfolio selection and warn of financial crises," The Quarterly Review of Economics and Finance, Elsevier, vol. 80(C), pages 480-493.
    9. Chikashi Tsuji, 2016. "Does the fear gauge predict downside risk more accurately than econometric models? Evidence from the US stock market," Cogent Economics & Finance, Taylor & Francis Journals, vol. 4(1), pages 1220711-122, December.
    10. Jaqueline Terra Moura Marins, 2020. "Option-Based Risk Aversion Indicators for Predicting Currency Crises in Emerging Markets," Working Papers Series 515, Central Bank of Brazil, Research Department.
    11. French, Joseph J. & Taborda, Rodrigo, 2018. "Disentangling the relationship between liquidity and returns in Latin America," Global Finance Journal, Elsevier, vol. 36(C), pages 23-40.
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    15. Peiwan Wang & Lu Zong & Ye Ma, 2019. "An Integrated Early Warning System for Stock Market Turbulence," Papers 1911.12596, arXiv.org.
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    17. Lutfa Tilat Ferdous & Khnd Md Mostafa Kamal & Amirul Ahsan & Nhung Hong Thuy Hoang & Munshi Samaduzzaman, 2022. "An Early Warning System for Currency Crises in Emerging Countries," JRFM, MDPI, vol. 15(4), pages 1-25, April.

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    More about this item

    Keywords

    Financial crises; S&P 500 options and futures; Early warning system (EWS); Multinomial logit models;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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