Regime shifts: early warnings

Florian Wagener

No 12-01, CeNDEF Working Papers from Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance

Abstract: A system that is at a steady state responds most of the time gradually to external changes. But in exceptional circumstances, it can exhibit a sudden 'catastrophic' shift to a different regime. It is of great practical interest to develop early warning indicators that signal the imminence of such a shift. A promising class of such indicators uses the universal fact that the average return time to a stable steady state after a small disturbance increases sharply close to a catastrophic shift. It is however important to realise that there are classes of dynamic regime shifts that cannot be predicted in this way. After reviewing the mathematical ideas behind these indicators, this article discusses their scope and their limitations.

Date: 2012
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