Safety from Currency Crashes

Kent Osband and Caroline Van Rijckeghem (cvanrijckeghem@istanbulanalytics.com)
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Kent Osband: International Monetary Fund

IMF Staff Papers, 2000, vol. 47, issue 2, 4

Abstract: As part of a proposed two-stage early warning system, we estimate "safety zones" for fundamentals under which currency crashes are unlikely to occur. We depart from traditional regression-based early warning systems and instead estimate the set of fundamentals for which currency crises never occurred and label this environment "safe or near-safe." For a sample of emerging markets from 1985 through 1998, we are able to classify 47 percent of the observed tranquil environments as safe or near-safe on a 12-month horizon, based on criteria in which external debt and reserves feature heavily. Nonparametric tests indicate that environments we identified as safe or near-safe bear less than a 1 percent risk of a currency crash. The results also pass a number of out-of-sample tests. Copyright 2000, International Monetary Fund

Date: 2000
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