Currency Crisis Early Warning Systems: Why They should be Dynamic

Traditionally, nancial crisis Early Warning Systems (EWSs) rely on macroeconomic leading indicators to forecast the occurrence of such events. This paper extends such discrete-choice EWSs by taking into account the persistence of the crisis phenomenon. The dynamic logit EWS is estimated using an exact maximum likelihood estimation method both in a time series and panel form. This model's forecasting abilities are then scrutinized by using an evaluation methodology recently designed specically for EWSs. When applied for predict- ing currency crises for 16 countries, this new EWS turns out to exhibit signicantly better predictive abilities than the existing static one, both in- and out-of -sample, thus supporting the use of dynamic specications for EWSs for nancial crises.