Early Warning Systems of Financial Crises - Implementation of a Currency Crisis Model for Indonesia

The objective of this paper is to implement a prototype of a currency crisis model as part of an early warning system framework for Indonesia. The financial systems of developing countries like Indonesia are especially vulnerable and therefore robust instruments to predict crises are needed. Our model is based on the signals approach developed by Kaminsky, Lizondo and Reinhart (1998) and Kaminsky and Reinhart (1999). The basic idea of the signals approach is to monitor several indicators that tend to exhibit an "unusual" behavior in the periods preceding a crisis. When an indicator crosses a threshold, then it is said to issue a "signal" that a currency crisis may occur within a given period. We implemented this signals approach for Indonesia. The outcomes of our calculations performed well and were economically validated.Keywords A Currency crisis, early warning systems, crisis prediction, Macroeconomic vulnerability indicators, signals approac