No. 588 - A multinomial approach to early warning system for debt crises

This paper develops an early warning system for sovereign debt crises, broadly defined as episodes of outright default, failure of a country to be current on external obligations and substantial access to IMF resources. It estimates a multinomial logit model that makes it possible to differentiate between three regimes labelled ‘tranquil’, ‘pre-crisis’ and ‘adjustment’. The model includes a large set of macroeconomic variables and is able to predict, in-sample, 78 per cent of onsets of crisis while sending false alarms in 34 per cent of tranquil cases; its out-of-sample performance is very similar, with 70 per cent of entries into crisis correctly predicted and 20 per cent of tranquil cases triggering false alarms.