The limiting conditional probability of an extreme currency crash given an extreme positive real interest rate signal is estimated as 30%.
“In our out-of sample assessment period from July 1995 through February 2008, the EVT methodology correctly identifies all well-known major currency crises, such as the 1997 Asian crisis, the crisis in Russia in 1998 and the crisis in Argentina in 2002.”
“The real interest rate on deposits is an indicator associated with issues such as over lending cycles, possible financial sector problems, a potential cause of future economic recession and a sign of a liquidity crunch. The domestic-foreign real interest rate differential is an indicator that captures a heightened risk premium for holding domestic currency assets and a potential cause of economic slowdown, bank fragility and the burst of asset price bubbles.”
The study failed to include many factors that may improve results, while limiting results to currency (instead of testing for banking, sovereign, and inflation crises), but it does show that real interest rates as a factor that may improve other crisis forecasting models.
