Banque de France
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How To Evaluate an Early Warning System? Towards a unified Statistical Framework for Assessing Financial Crises Forecasting Methods
This paper proposes an original and unified toolbox to evaluate financial 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 different 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 for predicting currency crises exclusively for South-Asian countries. Besides, the optimal cut-off correctly allows us to identify now on average more than 2/3 of the crisis and calm periods.
Currency Crises Early Warning Systems: why they should be Dynamic
This paper introduces a new generation of Early Warning Systems (EWS) which takes into account the dynamics, i.e. the persistence in the binary crisis indicator. We elaborate on Kauppi and Saikonnen (2008), which allows to consider several dynamic specifications by re- lying on an exact maximum likelihood estimation method. Applied so as to predict currency crises for fifteen countries, this new EWS turns out to exhibit significantly better predic- tive abilities than the existing models both within and out of the sample, thus vindicating dynamic models in the quest for optimal EWS.
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