Early Warning Systems: A Survey and a Regime-Switching Approach

IMF Working Papers, February 1, 2003

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Early Warning Systems: A Survey and a Regime-Switching Approach

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Bibliographic details

• Authors: Abdul d Abiad
• Published: February 1, 2003
• Series: IMF Working Papers
• DOI: https://doi.org/10.5089/9781451845136.001

Summary

• Previous early-warning systems (EWSs) for currency crises rely on models that require a priori dating of crises.
• This paper proposes an alternative EWS based on a Markov-switching model that:
  • Identifies and characterizes crisis periods endogenously.
  • Utilizes information contained in exchange rate dynamics.
• Model estimation is done using data for the period 1972-99 for the Asian crisis countries, taking a country-by-country approach.
• The Markov-switching model outperforms standard EWSs in:
  • Signaling crises.
  • Reducing false alarms.

Methodology

• Core approach: Markov-switching (regime-switching) model that allows endogenous identification of crisis episodes and incorporates exchange rate dynamics.
• Estimation: Country-by-country estimation for Asian crisis countries using data from 1972-99.

Key Findings

• The Markov-switching EWS outperforms standard EWSs on both detection and false-alarm reduction.
• Two main lessons emerge:
  • Accounting for the dynamics of exchange rates is important.
  • Different indicators matter for different countries; the assumption of parameter constancy underlying panel estimates of EWSs may contribute to poor performance.

Subjects and Keywords

• Subject: Currency crises, Early warning systems, Econometric analysis, Exchange rates, Financial crises, Foreign exchange, Markov-switching models
• Keywords: crisis date, crisis duration, crisis index, crisis measure, crisis probability, crisis vulnerability, crisis-identification threshold, Currency crises, Currency crisis, discriminant analysis, early warning system, Early warning systems, exchange rate, Exchange rates, Global, growth rate, identification method, Markov chain, Markov switching, Markov-switching models, nominal exchange rate, regime switching, short-term debt, WP

Content in this bundle

• Early-Warning Systems: A Survey and a Regime-Switching Approach - WP/03/32
  • Early-Warning Systems: A Survey and a Regime-Switching Approach - WP/03/32 (Markdown version)
  • Early-Warning Systems: A Survey and a Regime-Switching Approach - WP/03/32 (PDF)