Systemic Early Warning Systems for Eu15 Based on the 2008 Crisis

Abstract

Reliable forecasts of an economic crisis well in advance of its onset could permit effective preventative measures to mitigate its consequences. Using the EU15 crisis of 2008 as a template, we develop methodology that can accurately predict the crisis several quarters in advance in each country. The data for our predictions are standard, publicly available macroeconomic and market variables that are preprocessed by moving averages and filtering. The prediction models then utilize the filtered data to distinguish pre-crisis from normal quarters through standard statistical classification methodology plus a proposed new combined method, enhanced by an innovative threshold selection and goodness-of-fit measure. Empirical results are very satisfactory: Country-stratified 14-fold cross validation achieves 92.1% correct classification and 85.7% for both true positive rate and positive predictive value for the EU15 crisis of 2008. Results will be of use to policy makers, investors, and researchers who are interested in estimating the probability of a crisis as much as one and a half years in advance in order to deploy prudential policies.