Designing an early warning system for debt crises

This paper develops an early warning system for debt crises broadly defined as episodes of outright default or failure of a country to be current on external obligations. A multinomial model is applied, that allows to differentiate between three regimes: a 'tranquil' period, a 'crisis' state and an adjustment or 'post-crisis' phase. The model, estimated using a large set of macroeconomic variables, is able to predict 76% of entries into crisis while sending 36% of false alarms and has rather good out-of-sample performance. Finally the paper tries to integrate the analysis based on macroeconomic variables with the approach based on risky market instruments.