Towards a New Early Warning System of Financial Crises

67 Pages Posted: 17 Jan 2003

See all articles by Matthieu Bussière

Matthieu Bussière

Banque de France

Marcel Fratzscher

DIW Berlin; Centre for Economic Policy Research (CEPR)

Date Written: May 2002

Abstract

This paper develops a new Early Warning System (EWS) model for predicting financial crises, based on a multinomial logit model. It is shown that EWS approaches based on binomial discrete-dependent-variable models can be subject to what we call a post-crisis bias. This bias arises when no distinction is made between tranquil periods and crisis/post-crisis periods. We show that applying a multinomial logit model is a valid way of solving this problem and constitutes a substantial improvement in the ability to forecast financial crises. The empirical results reveal that the model would have correctly predicted a large majority of crises in emerging markets since the 1990s. Moreover, we derive general results about the optimal design of EWS models, which allows policy-makers to make an optimal choice based on their degree of risk-aversion against unanticipated financial crises.

Keywords: Currency crises, Early Warning System, crisis prediction

JEL Classification: F31, F47, F30

Suggested Citation

Bussiere, Matthieu and Fratzscher, Marcel, Towards a New Early Warning System of Financial Crises (May 2002). Available at SSRN: https://ssrn.com/abstract=357482

Matthieu Bussiere (Contact Author)

Banque de France ( email )

Paris
France

Marcel Fratzscher

DIW Berlin ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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