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Monitoring and Forecasting Currency Crises

Authors


  • We would like to thank two referees, the editor (Ken West), Lutz Kilian, Oscar Jorda, Steve Radchenko, Alessandro Tarozzi, and seminar participants at the 2004 Conference on Forecasting at Duke, University of California-Riverside, and the 2005 Econometric Society Winter Meetings for comments. Pedro Duarte and Viktor Todorov provided skilled research assistance.

Abstract

Can we improve forecasts of currency crises by using a large number of predictors? Which predictors should we use? This paper evaluates the performance of traditional leading indicators and a new Diffusion Index (DI) method as Early Warning Systems to monitor the risk and forecast the likelihood of the recent currency crises in East Asia. We find that the DI performs quite well in real time. For most countries, the forecasted probabilities of a crisis increase substantially around the actual time of the crisis. The economic variables that help in forecasting future crises are output growth, interest rates and money growth.

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