This study develops an early warning system for financial crises with a focus on small open economies. We contribute to the literature by developing macro-financial dynamic factor models that extract useful information from a rich but unbalanced mixed frequency data set that includes a range of global and domestic economic and financial indicators. The framework is applied to several Asian countries—Thailand, South Korea, Singapore, Malaysia, the Philippines and Indonesia. Logit regression models that use the extracted factors and other leading indicators have significant power in predicting systemic events. In-sample and out-of-sample test results indicate that the extracted factors help to improve the predictive power over a model that uses only sufficiently long history indicators. Importantly, models that include the dynamic factors yield consistently better out-of-sample crisis prediction results for key performance measures such as a usefulness index, the noise to signal ratio, and AUROC.

We test the effectiveness of Bank of Japan (BOJ)’s foreign exchange interventions on conditional first and second moments of exchange rate returns and traded volumes, using a bivariate EGARCH model of the Yen/USD market from 5-13-1991 to 3-16-2004. We also estimate a friction model of BOJ’s intervention reaction function based on reducing short-term market disorderliness and supplementing domestic monetary policy. Important finding of this study are that: (i) we find ineffectiveness of BOJ interventions in influencing exchange rate trends pre-1995, in general, but effectiveness post-1995; (ii) FED intervention amplified the effectiveness of the BOJ transactions; (iii) interventions amplified market volatility and volumes through a ‘learning by trading’ process; (iv) BOJ’s interventions were based on ‘leaning against the wind’ motivations on the exchange rate trend and volumes; and (v) BOJ interventions were vigorously used in support of domestic monetary policy objectives post-1995. Though some of our findings confirm recent studies, our analysis goes deeper to provide new findings with important implications for central banks and foreign exchange market participants.