Financial crisis prediction in Indonesia using combined of volatility and Markov switching models based on real interest rate on deposit and nominal exchange rate indicators

Abstract

The financial crisis has happened Indonesia 1997 and 2008. The crisis had brought the disadvantages impact on the economy of Indonesia. To anticipate the impact of the crisis, an early detection system that can detect some signs of a financial crisis is needed so that the government as a decision maker in maintain the stability of the economy. The crisis occurred due to hight volatility and structural changes in macroeconomic indicators. One of model that can be used to captured signals crisis is a combination of volatility and Markov switching. Fluctuations can be explained using volatility model, while some changes in conditions are explained through Markov switching. This study uses indicators of the real interest rate on deposit and nominal exchange rate to detect signals crisis in Indonesia. The results showed that the MS-ARCH(2,1) models of the real interest rate on deposit could only explain the crisis that occurred in 1997 and the MS-GARCH(3,1,1) models of nominal exchange rate could explain the crisis that occurred in 1997 and 2008. Based on the predicted value of smoothed probability, it shows that from July 2019 to June 2020, there are no signals of financial crisis in Indonesia.