Modeling Financial Crises Mutation

The recent financial turmoils in Latin America and Europe have led to a concatenation of several events from currency, banking and sovereign debt crises. This paper proposes a multivariate dynamic probit model that encompasses the three types of crises ’currency, banking and sovereign debt’ and allows us to investigate the potential causality between all three crises. To achieve this objective, we propose a methodological novelty consisting of an exact maximum likelihood method to estimate this multivariate dynamic probit model, extending thus Huguenin, Pelgrin and Holly (2009). Using a large sample of data for emerging countries, which experienced financial crises, we find that mutations from banking to currency (and vice-versa) are quite common. More importantly, the trivariate model turns out to be more parsimonious in the case of the two countries which suffered from the 3 types of crises. These findings are strongly confirmed by a conditional probability and an impulse-response function analysis, highlighting the interaction between the different types of crises and advocating hence the implementation of trivariate models whenever it is feasible. J.E.L. Codes: C33, F37