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How to evaluate an Early Warning System ?

  • Bertrand Candelon

    (LEO - Laboratoire d'économie d'Orleans - CNRS - UO - Université d'Orléans)

  • Elena-Ivona Dumitrescu

    ()

    (LEO - Laboratoire d'économie d'Orleans - CNRS - UO - Université d'Orléans)

  • Christophe Hurlin

    ()

    (LEO - Laboratoire d'économie d'Orleans - CNRS - UO - Université d'Orléans)

This paper proposes an original and uni ed toolbox to evaluate nancial crisis Early Warning Systems (EWS). It presents four main advantages. First, it is a model free method which can be used to asses the forecasts issued from di erent EWS (probit, logit, markov switching models, or combinations of models). Second, this toolbox can be applied to any type of crisis EWS (currency, banking, sovereign debt, etc.). Third, it does not only provide various criteria to evaluate the (absolute) validity of EWS forecasts but also proposes some tests to compare the relative performance of alternative EWS. Fourth, our toolbox can be used to evaluate both in-sample and out-of-sample forecasts. Applied to a logit model for twelve emerging countries we show that the yield spread is a key variable to predict currency crises exclusively for South-Asian countries. Besides, the optimal cut-o correctly allows us to identify now on average more than 2/3 of the crisis and calm periods.

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Date of creation: 01 Jan 2012
Handle: RePEc:hal:wpaper:halshs-00450050
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  1. Corsetti, Giancarlo & Pesenti, Paolo & Roubini, Nouriel, 1999. "Paper tigers?: A model of the Asian crisis," European Economic Review, Elsevier, vol. 43(7), pages 1211-1236, June.
  2. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany.
  3. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Early Warning System: Empirical Results from The Signals Approach," MPRA Paper 24577, University Library of Munich, Germany.
  4. Kaminsky, Graciela L. & Schmukler, Sergio L., 1999. "What triggers market jitters? A chronicle of the Asian crisis," Policy Research Working Paper Series 2094, The World Bank.
  5. Aaron Tornell, 1999. "Common Fundamentals in the Tequila and Asian Crises," Harvard Institute of Economic Research Working Papers 1868, Harvard - Institute of Economic Research.
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  8. Reinhart, Carmen & Kaminsky, Graciela, 2000. "Crisis financieras en Asia y Latinoamerica: ahora y entonces
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  9. Fratzscher, Marcel & Matthieu Bussiere, 2003. "Towards A New Early Warning System of Financial Crises," Royal Economic Society Annual Conference 2003 81, Royal Economic Society.
  10. Barry Eichengreen & Andrew K. Rose & Charles Wyplosz, 1996. "Contagious Currency Crises," NBER Working Papers 5681, National Bureau of Economic Research, Inc.
  11. Hali J. Edison, 2003. "Do indicators of financial crises work? An evaluation of an early warning system," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(1), pages 11-53.
  12. Chou, Ray Yeutien, 2005. "Forecasting Financial Volatilities with Extreme Values: The Conditional Autoregressive Range (CARR) Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(3), pages 561-82, June.
  13. Laurent-Emmanuel Calvet & Adlai J. Fisher, 2004. "How to Forecast Long-Run Volatility: Regime Switching and the Estimation of Multifractal Processes," Post-Print hal-00478472, HAL.
  14. Susmel, Raul, 2000. "Switching Volatility in Private International Equity Markets," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(4), pages 265-83, October.
  15. Reinhart, Carmen & Kaminsky, Graciela & Lizondo, Saul, 1998. "Leading Indicators of Currency Crises," MPRA Paper 6981, University Library of Munich, Germany.
  16. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333.
  17. Franc Klaassen, 2002. "Improving GARCH volatility forecasts with regime-switching GARCH," Empirical Economics, Springer, vol. 27(2), pages 363-394.
  18. Parkinson, Michael, 1980. "The Extreme Value Method for Estimating the Variance of the Rate of Return," The Journal of Business, University of Chicago Press, vol. 53(1), pages 61-65, January.
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