the impact of emu on real exchange rate volatility of eu.pptVIP

EARLY WARNING SYSTEMS FOR BANKING CRISES E Philip Davis NIESR and Brunel University West London e_philip_davis@ /group/financial_stability Introduction 3 types of models for early warning, logit, signal extraction and binary recursive tree We apply the models first to prediction of crises in Asia And then outline a new logit approach which predicts banking crises in OECD countries Early warning systems Multivariate logit model uses macroeconomic, institutional and financial variables X as inputs to calculate probability of a banking crisis Y as the output via logistic function estimator. Suitable for answering question “what is the likelihood of a banking crisis occurring in the next t years?” Non-parametric signal extraction approach tracks individual time series X prior to and during crisis episodes to answer question “is there a signal S of future crisis or not?” If an input variable’s aberrant behaviour can be quantitatively defined whenever that variable moves from tranquil to abnormal activity, a crisis is forewarned. { S ij = 1 } = { │ Xij │ │ X*ij │ } or { S ij = 0 } = { │ Xij │ │ X*ij │ } Binary Recursive Tree (BRT) can be used to answer question “which non-linear variable interactions make an economy more vulnerable to crisis than others?” Argued that liquidity, credit and market risks are all potentially non-linear. Estimator identifies single most important discriminator between crisis and non-crisis episodes across the entire sample, thereby creating two nodes. Nodes are further split into sub-nodes based on the behaviour of splitter variables’ non-linear interactions with previous splitter variables. This generates nodal crisis probabilities and the associated splitter threshold values. Advantages and disadvantages Logistic models are ideally suited to predicting a binary outcome (1 = banking crisis, 0 = no banking crisis) using multiple explanatory variables selected on the basis of their theoretical or observed associations with banking cr