Fundamental Pitfalls of Exchange Market Pressure-Based Approaches to Identification of Currency Crises

This study seeks to demonstrate that the identification of crisis episodes based on commonly applied exchange market pressure (EMP) indices, namely, Eichengreen, Rose and Wyplosz (1995), Sachs, Tornell and Velasco (1996), and Kaminsky, Lizondo and Reinhart (1998) are highly sensitive to the choice of: a) the weighting scheme for each component of the EMP index; and b) the statistical parametric assumption used in the constructions of crisis thresholds. To highlight further some of the potential consequences of these two pitfalls in identifying crisis episodes, this paper employs a number of possible alternative approaches to measure the exchange market pressure.