Use of Unit Root Methods in Early Warning of Financial Crises

35 Pages Posted: 7 Nov 2016  

Timo Virtanen

University of Turku - Turku School of Economics

Eero Tölö

Bank of Finland - Financial Markets

Matti Viren

Bank of Finland - Research

Katja Taipalus

Bank of Finland - Financial Stability and Statistics

Date Written: 2016

Abstract

Unit root methods have long been used in detection of financial bubbles in asset prices. The basic idea is that fundamental changes in the autocorrelation structure of relevant time series imply the presence of a rational price bubble. We provide cross-country evidence for performance of unit-root-based early warning systems in ex-ante prediction of financial crises in 15 EU countries over the past three decades. We then combine the identified early warning signals from multiple time series into a composite indicator. We also show that a mix of data with different frequencies may be useful in providing timely warning signals. Our results suggest and an early warning tool based on unit root methods provides be a valuable accessory in financial stability supervision.

Keywords: financial crises, unit root, combination of forecasts

JEL Classification: G01, G14, G21

Suggested Citation

Virtanen, Timo and Tölö, Eero and Viren, Matti and Taipalus, Katja, Use of Unit Root Methods in Early Warning of Financial Crises (2016). Bank of Finland Research Discussion Paper No. 27/2016. Available at SSRN: https://ssrn.com/abstract=2864857

Timo Virtanen

University of Turku - Turku School of Economics

Rehtorinpellonkatu 3
TURKU, FI-20500
Finland

Eero Tölö (Contact Author)

Bank of Finland - Financial Markets ( email )

P.O Box 160
FIN-00101 Helsinki
Finland

Matti Viren

Bank of Finland - Research ( email )

P.O Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2563 (Phone)
+358 10 831 2294 (Fax)

Katja Taipalus

Bank of Finland - Financial Stability and Statistics ( email )

Finland

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