Do Indicators of Financial Crises Work? An Evaluation of an Early Warning System

76 Pages Posted: 10 Jan 2001

See all articles by Hali J. Edison

Hali J. Edison

International Monetary Fund (IMF) - Research Department

Date Written: July 2000

Abstract

The object of this paper is to develop an operational early warning system (EWS) that can detect financial crises. To achieve this goal the paper analyzes and extends the early warning system developed by Kaminsky, Lizondo, and Reinhart (1998) and Kaminsky and Reinhart (1999) that is based on the "signal" approach. This system monitors several indicators that tend to exhibit an unusual behavior in the periods preceding a crisis. When an indicator exceeds (or falls below) a threshold, then it is said to issue a "signal" that a currency crisis may occur within a given period. The model does a fairly good job of anticipating some of the crises in 1997/1998, but several weaknesses to the approach are identified. The paper also evaluates how this system can be applied to an individual country. On balance, the results in this paper are mixed, but the results suggest that an early warning system should be thought of as a useful diagnostic tool.

Keywords: Currency Crises, vulnerability indicators, Asian crisis, balance of payments crisis, crisis prediction

JEL Classification: F31, F47

Suggested Citation

Edison, Hali J., Do Indicators of Financial Crises Work? An Evaluation of an Early Warning System (July 2000). Available at SSRN: https://ssrn.com/abstract=238249 or http://dx.doi.org/10.2139/ssrn.238249

Hali J. Edison (Contact Author)

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-6946 (Phone)
202-589-6946 (Fax)

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