Adaptive early warning systems: An axiomatic approach

Abstract

The U.S. Subprime Crisis and the subsequent Great Recession have highlighted a renewed interest in the proper design and implementation of Early Warning Systems (E.W.S.), in order to help deter the onset of subsequent extreme financial events, through the implementation of adequate crisis detection mechanisms. The present article describes the Adaptive Early Warning Systems (A.E.W.S.) axiomatic approach, as a natural operational extension to E.W.S. testing. This novel protocol upholds the operational dimension of implementing an efficient holistic crisis detection mechanism, a domain which has been hitherto overlooked by the E.W.S. literature. The paper first describes the major axiomatic principles sustaining the A.E.W.S. protocol, which seek to establish universal principles in support of the said protocol. Second, the article also describes a basic universal template for an A.E.W.S. surveillance platform, which duly describes how multiple testing procedures can be integrated into a single crisis detection framework, while targeting multiple segments of the financial markets (such as the conventional and non-conventional segments of the financial markets). Third, the paper also describes the major advantages and disadvantages associated with the implementation of this novel protocol. It is hoped that the effective implementation of the A.E.W.S. protocol as a novel operational framework in the global macroprudential toolkit might help deter the onset of future extreme financial events, by enabling a greater cohesiveness in E.W.S.-related central banking procedures, as well as promoting a greater international central banking cooperation prior to and during financial distress episodes.