Early Warning System.

The Early Warning System was originally developed by Kaminsky, Lizondo and Reinhart (KLR) in 1998. Their system was based on a signal approach. In this approach the system monitors unusual behaviors of indicators preceding a crisis. However, a senior economist in the division of International Finance identified weaknesses in the original Early Warning System. Hali J. Edison saw the need to evaluate and improve upon the econometric model that was used to anticipate financial crises specifically …

…of the exchange rate. (b) The volatility of the interest rates. (c) Changes in the inflation rate. (d) Variables that capture contagion The more volatile are inflation, interest rates, and exchange rates, the higher are the risks for financial institutions. An explanatory variable characterizing the financial and trade links between countries might also improve the performance of the model as the occurrence of financial crises in other countries could trigger a financial crisis domestically. (Edison,2000)