Predicting currency crisis in Indonesia based on real output and Indonesia Composite Index (ICI) indicators

Abstract

The currency crisis that occurred in the middle of 1997, 1998 and 4th quarter of 2008 was caused by disturbances in the currency system. When there is disturbance in the system then the cause indicators will experience fluctuations and changes in conditions. High fluctuation can be modeled using volatility model, while the changes in condition can be modeled using Markov switching model. Therefore, combination of volatility and Markov switching models is very appropriate to explain the crisis. In this paper, we use real output and ICI indicators on the period of January 1990 until December 2016 to explain the crisis as well as to forecast the possibility of an impending crisis. The results show that the appropriate model is ARCH (1) and Markov switching with 3 states, called SWARCH (3,1) model. This model can catch the crisis that happened in 1998 and 1999 for real output indicator. Meanwhile ICI indicator can explain the crisis in August to December 1997, 1998 and September to December 2008. Based on SWARCH (3,1) model, it can be predicted that Indonesia does not experience currency crisis in one year later.