This research project is implemented as part of the on-going work of the SEACEN Expert Group (SEG) on Capital Flows. It aims to further utilise the SEG data that have been regularly reported to the SEACEN Centre and shared among the SEG members. The project aims to establish a regional Early Warning System (EWS) model to support the data analysis work at the SEACEN Centre. As the SEG EWS is for capital flows a signaling non-parametric approach was applied to all the candidate variables and contagion-related variables in order to obtain good leading indicators which could serve as a warning signal for capital flow crisis. More than 30 variables passed the noise-signal ratio test. All these variables are then combined into a composite index (CI) and five sectoral indices. These indices were then tested for their abilities in predicting capital flow crisis. Due to limited availability of data the study was not able to conduct an out-of-sample test for the CI. However conditional probabilities of the CI in some ranges were examined and they were found to be capable for monitoring and assessing adverse movements of capital flows. While more rigorous tests on the robustness of the model are required the initial results suggest that the model has a good potential to provide early warnings of capital flows reversal in the SEG region. Further work to refine the model however will require more data of high quality which in turn requires cooperation from SEG members in submitting these data. At the 5th SEG Meeting the SEG agreed that the EWS model could be useful and suggested further refinements on the model. The SEG also suggested that the revised model should be discussed at the 3rd Technical SEG Meeting to be conducted during the 3rd quarter of OY 2005/06. The final model should be presented to the SEG again. It was also agreed that when the model is finalised a report providing a snapshot of the CI and signals of the individual indicators should be shared among the member countries every quarter.
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