Currency crisis early warning systems: Why they should be dynamic

Traditionally, financial crisis EarlyWarning Systems (EWSs) have relied onmacroeconomic leading indicatorswhen forecasting the occurrence of such events. This paper extends such discrete-choice EWSs by taking the persistence of the crisis phenomenon into account. The dynamic logit EWS is estimated using an exact maximum likelihood estimation method in both a country-by-country and a panel framework. The forecasting abilities of this model are then scrutinized using an evaluationmethodologywhichwas designed recently, specifically for EWSs. When used for predicting currency crises for 16 countries, this new EWS turns out to exhibit significantly better predictive abilities than the existing static one, both inand out-of-sample, thus supporting the use of dynamic specifications for EWSs for financial crises. © 2014 International Institute of Forecasters. Published by Elsevier B.V. All rights reserved.