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Systemic Event Prediction by Early Warning System

Author

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  • Diana Zigraiova

    () (Czech National Bank and Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)

  • Petr Jakubik

    () (European Insurance and Occupational Pensions Authority (EIOPA) and Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic)

Abstract

This work develops an early warning system framework for assessing systemic risks and for predicting systemic events, i.e. periods of extreme financial instability with potential real costs, over the short horizon of six quarters and the long horizon of twelve quarters on the panel of 14 countries, both advanced and developing. First, we build Financial Stress Index to identify starting dates of systemic financial crises for each country in the panel. Second, early warning indicators for assessment and prediction of systemic risks are selected in a two-step approach; relevant prediction horizons for each indicator are found by the univariate logit model followed by the application of Bayesian model averaging method to identify the most useful indicators. Next, we validate early warning model, containing only useful indicators, for both horizons on the panel. Finally, the in-sample performance of the constructed EWS over both horizons is assessed for the Czech Republic. We find that the model over the 3 years’ horizon slightly outperforms the EWS with the horizon of 1.5 years on the Czech data. The long model attains the maximum utility in crises detection as well as it maximizes area under Receiver Operating Characteristics curve which measures the quality of the forecast.

Suggested Citation

  • Diana Zigraiova & Petr Jakubik, 2014. "Systemic Event Prediction by Early Warning System," Working Papers IES 2014/01, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Jan 2014.
  • Handle: RePEc:fau:wpaper:wp2014_01
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    File URL: http://ies.fsv.cuni.cz/sci/publication/show/id/5023/lang/cs
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    References listed on IDEAS

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    Cited by:

    1. Frantisek Brazdik & Jan Bruha & Michal Franta & David Havrlant & Tibor Hledik & Tomas Holub & Zuzana Humplova & Frantisek Kopriva & Jiri Polansky & Marek Rusnak & Jaromir Tonner, 2015. "Forecasting," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, edition 1, volume 13, number rb13/1 edited by Jan Babecky & Kamil Galuscak.
    2. Michal Andrle & Oxana Babecka Kucharcukova & Jaromir Baxa & Jan Bruha & Peter Claeys & Jan Filacek & Jakub Mateju & Miroslav Plasil & Serhat Solmaz & Borek Vasicek, 2015. "Monetary Policy Challenges in a Low-Inflation Environment," Occasional Publications - Edited Volumes, Czech National Bank, Research Department, edition 2, volume 13, number rb13/2 edited by Jan Babecky & Michal Franta.

    More about this item

    Keywords

    Systemic risk; Financial stress; Financial crisis; Early warning indicators; Bayesian model averaging; Early warning system;

    JEL classification:

    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • G01 - Financial Economics - - General - - - Financial Crises

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