Developing EWS Models for Contemporary Crises Using Extreme Value Binary Models: The Cases of Eurozone and Argentinian Peso (2014)

Developing EWS Models for Contemporary Crises Using Extreme Value Binary Models: The Cases of Eurozone and Argentinian Peso (2014)

Dimitrios K. Dapontas (University of Peloponnese, Greece)
DOI: 10.4018/978-1-4666-9484-2.ch016
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Abstract

This chapter is presenting the most contemporary crises following the 2008 credit crunch and small scale following crises. Our sample consists of five countries (Cyprus, Greece, Ireland, Portugal and Argentine respectively) hit by crisis during 2010's. The Early Warning System (EWS) proposed is the Extreme Value Model (EVA) used previously for natural disasters and irregular phenomena. Its major advantage compared to other binary models is its focus to the turbulence periods and their characteristics contrast to possible trend models which exclude them. The results show that EVA fits better forecast and it gave positive and calm signals than similar logit and probit models for all five cases examined.
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Introduction

If forecasting forthcoming crises is fascinating, preventing crises before been occurred is tremendous. Latest crisis following the global credit crunch hit Eurozone countries exposed structural problems little known before and put global economy under doubt. The existence of a common currency scheme dilated crisis definition from depreciation to sharp exchange reserves decline or interest rate spread raise sharing single currency. Argentina’s incident on January 2014 is another example of a fast occurring crisis leading to latter bankruptcy. The fascinating history of crises continues and new and more complicated and requisite methods are availed to unravel faster and rigidly stiffer crises. For these turbulences predicting we deployed the Extreme Value Model (EVM) as an Early Warning System (EWS) used previously on rare events prediction such as natural disasters and recently applied to currency crisis forecasting literature as more appropriate. EVS has major advantages comparing to other binary methods applied earlier focusing on crisis period against the trend. The chapter is structured as follows; in the present part the ingress is displayed following by the literature review. On the third section main content of the chapter is presented divided to three parts (Issues and problems arisen, variables used and extreme value model results respectively) and finally the fourth fragment gives extracted conclusions and proposals for further research.

Key Terms in this Chapter

Currency Crisis: A situation in which there is serious doubt as to whether a country's central bank has enough foreign exchange reserves to maintain the country’s fixed exchange rate. The crisis is often accompanied by a speculative attack in the foreign exchange market.

Financial Contagion: Refers to “the spread of market disturbances -- mostly on the downside -- from one country to the other, a process observed through co-movements in exchange rates, stock prices, sovereign spreads, and capital flows.

Bailout: A colloquial term for giving financial support to a company or country which faces serious financial difficulty or bankruptcy.

Extreme Value Model: A model which seeks to assess, from a given ordered sample of a given random variable, the probability of events that are more extreme than any previously observed.

Sovereign Default: Is the failure or refusal of the government of a sovereign state to pay back its debt in full.

Theoretical Models Generations: The currency crises and sovereign debt crises that have occurred with increasing frequency since the Latin American debt crisis of the 1980s have inspired a huge amount of research. There have been several 'generations' of models of currency crises. First generation focuses on investor’s behaviour, second generation on institutional roles, third generation on contagion and fourth generation on system asymmetries and weaknesses.

EFSF: The European Financial Stability Facility (EFSF) was created as a temporary crisis resolution mechanism by the euro area Member States in June 2010. The EFSF has provided financial assistance to Ireland, Portugal and Greece. The assistance was financed by the EFSF through the issuance of bonds and other debt instruments on capital markets.

Early Warning System: Statistically-based model that estimates the probability of failure or financial distress of an individual bank or banking system, over a fixed time horizon.

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