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Cross-country linkages and spill-overs in early warning models for financial crises

Jan Hannes Lang ()

No 2160, Working Paper Series from European Central Bank

Abstract: This paper uses data on bilateral foreign exposures of domestic banking systems in order to construct early warning models for financial crises that take into account cross-country spill-overs of vulnerabilities. The empirical results show that incorporating cross-country financial linkages can improve the signalling performance of early warning models. The relative usefulness increases from 65% to 87% and the AUROC from 0.89 to 0.97 when weighted foreign variables are added to domestic variables in a multivariate logit early warning model. The findings of the paper also suggest that global variables still play a role in predicting financial crises, even when foreign variables are controlled for, which could suggest that both cross-country spill-overs and contagion are important factors for driving financial crises. A parsimonious model with nine variables that combines domestic, foreign and global variables yields an out-of-sample relative usefulness of 0.82 with Type I and Type II errors of 0.11 and 0.07. JEL Classification: G01, G17, F37, F65

Keywords: early warning models; financial crises; financial linkages (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dcm
Date: 2018-06
Note: 2731285
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Handle: RePEc:ecb:ecbwps:20182160