reserves – is two or three (country-specific) standard deviations above its (country-specific) mean. 3 In this context, a relevant question is: should a currency crisis be defined as a situation when the exchange rate pressure index is two or three standard deviations above its mean? Since there is no clear consensus in the EWS literature about which crisis definition should be used, we attempt to fill this gap by taking an agnostic approach. We use two definitions of currency crisis. According to one definition, a currency crisis occurs when the exchange rate pressure
crisis definitions and assessed within a single model when effective to improve evenhandedness. They also represent a step forward in risk assessment modeling, leveraging the recent advances in modeling macroeconomic risks with ML tools. Machine-learning tools are well-suited to the challenges of macroeconomic risk assessments . Crises are rare and almost always involve novel features (otherwise they would have been anticipated). When they materialize, they often reveal economic relationships which are not regularly observed in normal times, making it challenging to
. Their results are consistent with ours in that they find explanatory power for models using monthly data (especially in the case of the probit model). However, the crisis definition they use is based on a measure of currency pressure. They do not focus, as we do, on trading strategies and their out-of-sample evaluations are based on quite small hold-out samples (just the 1997 Asian crisis). B. Logit-Based Crisis Forecasting Much of the literature described above seeks to explain the origins of currency crises by relating their occurrence to contemporaneous
F inancial crises in emerging market economies have been the subject of considerable analysis. This section draws on work to date to provide essential background for the subsequent sections. Definitions Financial Crises Most studies of financial crises distinguish between currency, debt, and banking crises. 3 These three types of crisis are discussed in Box 2.1 . Empirical studies—including this one—typically make such a distinction because it is helpful to use specific, and therefore relatively narrow, crisis definitions. 4 But many of the
, 2001 ) and regime switching with time-varying probabilities ( Abiad, 2003 ). Some studies depart from a regression-based setting altogether: Osband and Van Rijckeghem (2000) use classification rules to identify safety zones for fundamentals under which currency crashes are unlikely to occur, and Ghosh and Ghosh (2002) use a binary recursive tree technique to explore complex interactions among structural and economic variables. Many of the proposed approaches look promising, and most report some improvement over the benchmark models. Differing crisis definitions
more recent model, the Deutsche Bank Alarm Clock (DBAC). Table 1 summarizes the main features of the models under consideration here. It details the crisis definition employed, the prediction horizon, the method used to generate predictions, and the predictor variables. Appendix I contains a more complete description of the models. Table 6 , in Appendix I , shows all the crisis dates for these models since January 1999. 4 Table 1. Specification of Early Warning Models DCSD 1/ (Berg, Borensztein, Milesi- Ferretti, and Pattillo) KLR 2