Early Signs of Financial Crises

For most diseases, it is always better to medically intervene earlier compared to later. This is because treatment at an early stage is generally more effective, and less expensive. The same is probably true for economies and financial markets. In the current global financial crisis, we have seen billions of dollars sunk into relief and stimulus packages, with hardly any positive result to show for the effort. The reason is clear: these intervention measures are too late. To implement more effective, and less costly economic and fiscal policies, it is important to detect the onset of a financial crisis early. At the same time, we do not want excessive reactions, when the market has merely caught a ’cold’. In this talk, I will describe recent work, based on the statistical segmentation and clustering analysis of financial time series data, that points to characteristic early signs prior to financial crises, characteristic early signs prior to a true recovery, and the characteristic time scales involved for both processes. By looking into a period that covers both the current crisis, as well as the most recent past crisis, we also hope to learn lessons on which intervention measures are effective, and which intervention measures are not.