Using a Threshold Approach to Flag Vulnerabilities in CESEE Economies

In this paper we examine macroeconomic, external and financial vulnerabilities of 22 Central, Eastern and Southeastern European (CESEE) economies. Our assessment is based on a nonparametric signaling or threshold approach, which involves monitoring selected indicators that show unusual behavior in the periods leading to a crisis. For that purpose, we have collected annual data on more than 90 emerging economies spanning the period from 1995 to 2012. Our dataset covers a broad range of potential early warning indicators related to the banking sector, the external side, and the macroeconomic and fiscal situation of the economy. Our in-sample test shows that the threshold approach identifies 73% of crisis events correctly while issuing false alarms only for 31% of the noncrisis observations. For the purpose of this paper, crisis events comprise banking crises, currency crises and sovereign debt crises. Applying a composite vulnerability indicator to CESEE economies using the latest available data (2012), we identify Turkey, Belarus and Moldova as the countries that appear especially vulnerable to an unexpected adverse event based on our threshold approach.