Assessing Financial Vulnerability: An Early Warning System for Emerging Markets
150Assessing Financial Vulnerability: An Early Warning System for Emerging Markets
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Overview
The European currency crises of 1992-93, the Mexican crisis of 1994-95, and especially the Asian/global crisis of 1997-98, have all contributed to a heightened interest in the early warning signals of financial crises. This pathbreaking study presents a comprehensive battery of empirical tests on the performance of alternative early warning indicators for emerging-market economies that should prove useful in the construction of a more effective global warning system.
Not only are the authors able to draw conclusions about which specific indicators have sent the most reliable early warning signals of currency and banking crises in emerging economies, they also test the out-of-sample performance of the model during the Asian crisis and find that it does a good job of identifying the most vulnerable economies. In addition, they show how the early warning system can be used to construct a "composite" crisis indicator to weigh the importance of alternative channels of cross-country "contagion" of crises, and to generate information about the recovery path from crises.
This timely study comes on the eve of impending changes at the International Monetary Fund as that institution reexamines how it reacts to financial crises. Moreover, the study provides "... a wealth of valuable elements for anyone investigating and forecasting adverse developments in emerging markets as well as industrial countries," according to Ewoud Schuitemaker, vice president of the economics department at ABN AMRO Bank.
Product Details
ISBN-13: | 9780881323047 |
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Publisher: | Peterson Institute for International Economics |
Publication date: | 06/01/2000 |
Sold by: | Barnes & Noble |
Format: | eBook |
Pages: | 150 |
File size: | 2 MB |
About the Author
Morris Goldstein, nonresident senior fellow, has held several senior staff positions at the International Monetary Fund (1970–94), including Deputy Director of its Research Department (1987–94). From 1994 to 2010, he held the Dennis Weatherstone Senior Fellow position at the Peterson Institute. He has written extensively on international economic policy and on international capital markets.
Carmen M. Reinhart was the Dennis Weatherstone Senior Fellow at the Peterson Institute for International Economics. She was previously professor of economics at the University of Maryland.
Graciela L. Kaminsky is professor of Economics and International Affairs at George Washington University and Research Associate at the National Bureau of Economic Research. She previously held positions as assistant professor at the University of California, San Diego and staff economist at the Board of Governors of the Federal Reserve System. She has been a Visiting Scholar at numerous government organizations, including the Bank of Japan, the Bank of Spain, the Federal Reserve Bank of New York, the Hong Kong Monetary, and the Monetary Authority of Singapore.
Table of Contents
Preface | ix | |
Acknowledgments | xv | |
1 | Introduction | 1 |
Organization of the book | 9 | |
2 | Methodology | 11 |
General Guidelines | 11 | |
Putting the Signals Approach to Work | 18 | |
3 | Empirical Results | 33 |
The Monthly Indicators: Robustness Check | 33 | |
The Annual Indicators: What Works? | 38 | |
Do the Indicators Flash Early Enough? | 40 | |
Microeconomic Indicators: Selective Evidence | 42 | |
4 | Rating the Rating Agencies | 45 |
Do Sovereign Credit Ratings Predict Crises? | 45 | |
Why Do Credit Ratings Fail to Anticipate Crises? | 49 | |
Do Financial Markets Anticipate Crises? | 52 | |
5 | An Assessment of Vulnerability: Out-of-Sample Results | 55 |
Vulnerability and Signals | 56 | |
A Composite Indicator and Crises Probabilities | 64 | |
6 | Contagion | 73 |
Defining Contagion | 74 | |
Theories of Contagion and Their Implications | 75 | |
Empirical Studies | 76 | |
Trade and Financial Clusters and a Composite Contagion Index | 77 | |
What the Index Reveals about Three Recent Crisis Episodes | 79 | |
7 | The Aftermath of Crises | 85 |
The Recovery Process | 85 | |
Some Caveats | 89 | |
8 | Summary of Results and Concluding Remarks | 95 |
Summary of Findings | 95 | |
Would the Publication of the Indicators Erode Their Early Warning Role? | 109 | |
Do the Better Performing Indicators Carry Policy Implications? | 110 | |
Appendix A | Data and Definitions | 111 |
References | 115 | |
Index | 121 | |
Tables | ||
Table 1.1 | Emerging Asia: real GDP growth forecasts, 1996-98 | 3 |
Table 1.2 | Rating agencies' performance before the Asian crisis: Moody's and Standard & Poor's long-term debt ratings, 1996-97 | 4 |
Table 2.1 | Currency crisis starting dates | 22 |
Table 2.2 | Banking crisis starting dates | 24 |
Table 2.3 | Selected leading indicators of banking and currency crises | 26 |
Table 2.4 | Optimal thresholds | 29 |
Table 2.5 | Examples of country-specific thresholds: currency crises | 30 |
Table 3.1 | Ranking the monthly indicators: banking crises | 34 |
Table 3.2 | Ranking the monthly indicators: currency crises | 35 |
Table 3.3 | Annual indicators: banking crises | 38 |
Table 3.4 | Annual indicators: currency crises | 39 |
Table 3.5 | Short-term debt: selected countries, June 1997 | 40 |
Table 3.6 | How leading are the signals? | 41 |
Table 3.7 | Microeconomic indicators: banking crises | 42 |
Table 4.1 | Comparison of Institutional Investor sovereign ratings with indicators of economic fundamentals | 46 |
Table 4.2 | Do ratings predict banking crises? | 48 |
Table 4.3 | Do ratings predict currency crises? | 48 |
Table 4.4 | Do ratings predict banking crises for emerging markets? | 50 |
Table 4.5 | Do ratings predict currency crises for emerging markets? | 50 |
Table 4.6 | Rating agencies' actions on the eve and aftermath of the Asian crisis, June-December 1997 | 51 |
Table 4.7 | Do financial crises help predict credit rating downgrades? (Institutional Investor) | 52 |
Table 4.8 | Do financial crises predict credit rating downgrades? (Moody's) | 52 |
Table 5.1 | Signals of currency crises, June 1996-June 1997 | 57 |
Table 5.2 | Borderline signals of currency crises, June 1996-June 1997 | 59 |
Table 5.3 | Signals of banking crises, June 1996-June 1997 | 60 |
Table 5.4 | Borderline signals of banking crises, June 1996-June 1997 | 61 |
Table 5.5 | Weighting the signals for currency and banking crises in emerging markets, June 1996-June 1997 | 62 |
Table 5.6 | Vulnerability to financial crises in emerging markets: alternative measures, June 1996-June 1997 | 63 |
Table 5.7 | Composite indicator and conditional probabilities of financial crises | 66 |
Table 5.8 | Scoring the forecasts: quadratic probability scores | 67 |
Table 6.1 | Crises that showed few signals, 1970-97 | 74 |
Table 6.2 | Conditional probabilities and noise-to-signal ratios for financial and trade clusters | 77 |
Table 6.3 | Countries sharing financial and trade clusters with original crisis country or region | 80 |
Table 6.4 | Contagion vulnerability index | 81 |
Table 6.5 | Characteristics of affected countries in Asian and Mexican episodes | 82 |
Table 6.6 | Asia and Latin America: added power of Thai crisis in explaining probability of contagion in bank cluster, July 1997 | 83 |
Table 7.1 | Length of recovery from financial crises | 86 |
Table 7.2 | Time elapsed from beginning of banking crises to their peaks | 87 |
Table 7.3 | Comparison of inflation and growth before and after currency crises | 88 |
Table 7.4 | The wake of devaluations: a review of the literature | 90 |
Table 7.5 | Comparison of severity of crises by region and period, 1970-97 | 92 |
Table 8.1 | Currency and banking crises: best performing indicators | 97 |
Table 8.2 | Country rankings of vulnerability to currency crises for two periods | 99 |
Table 8.3 | Country rankings of vulnerability to banking crises for two periods | 101 |
Figures | ||
Figure 2.1 | Mexico: real exchange rate, 1970-96 | 31 |
Figure 5.1 | Probability of currency crises for four Southeast Asian countries, 1990-97 | 69 |
What People are Saying About This
Barry Eichengreen, University of California, Berkeley:
. . . the best available effort to build an 'early warning system'.
Holger Wolf, Georgetown University:
. . . a well-written and innovative treatment of an important topic and should be of great interest to both practitioners and academics.
Peter Montiel, International Monetary Fund:
(Provides) a definitive presentation of the 'early warning indicator' methodology for crisis prediction . . .Without a doubt, this is a book that I would want to have on my shelves.