Prediction of Indonesian financial crisis using Markov regime switching autoregressive conditional heteroscedasticity models based on bank deposits and lending/deposit interest rate indicators

Abstract

The financial crisis that occurred in middle of 1997 made Indonesia to become one of the countries which had the worst and the longest affected in term of its rate of recovery. This event made us aware of the importance of creating an early warning system for the financial crisis. The crisis occurred due to several macroeconomic indicators experiencing very high fluctuation and changes in the structure of the condition (regime). The combination of volatility and Markov regime switching models is a type of model that can explain the fluctuation and changes in such condition. The indicators of bank deposit and lending/deposit interest rate in January 1990 to June 2019 were used to construct the combined model. The results of this research showed that the MRS-ARCH(2,1) model for the bank deposit and lending/deposit interest rate indicators can explain the conditions of the financial crisis that occurred. The predicted value of the MRS-ARCH(2,1) model shows that from July 2019 to June 2020 there were no signs of a financial crisis in Indonesia.