At the end of 2022, the domestic financial market suffered greatly. Gangwon-do Governor Kim Jin-tae announced the application for rehabilitation of Gangwon-do Development Corporation, established by Gangwon-do to create Legoland, and defaulted the asset-backed commercial paper (ABCP) guaranteed by Gangwon-do. The bond market suffered massive turmoil. The government expanded the market liquidity program, and the Bank of Korea announced a liquidity support policy worth 42 trillion won.
It was discovered that crisis warnings regarding this situation, which was recorded as the largest financial market crisis since COVID-19, had been appearing for about six months. This is based on the artificial intelligence-based early warning model recently developed by the Bank of Korea.
AI alarm model with excellent predictive power
On the 24th, the Bank of Korea announced ‘BOK Issue Note: Data-based Finance and Foreign Exchange Early Warning Model’ introducing this model. According to this model developed by Tae-wan Kim, Deputy Director of the Financial Payments Bureau, Jeong-hee Park, Manager of the Digital Innovation Office, and Hyeon-chang Lee, Head of the Digital New Technology Team, the early warning index has been shown to have continued to rise since the second quarter of 2022. This means that warning sounds were sounded for about six months until it rose to 0.5 in November 2022.
The early warning index newly created by the Bank of Korea was calculated through artificial intelligence (AI) and machine learning (ML)-based learning. It is characterized by analyzing variables that determine the vulnerability of the financial system and variables (triggers) that trigger a crisis.
Vulnerability variables are leverage, financing, and asset price variables. It consists of debt-to-GDP ratio, bank leverage, short-term foreign debt ratio, and housing sales price index. Trigger variables include tight monetary policies in major countries and trade disputes, but these are factors that are difficult to quantify. Because of these limitations, the researchers evaluated trigger variables using the volatility index (VIX), won-dollar exchange rate volatility, and interest rate spread.
When we simulated the situation in 2022 using the model created in this way, the result was that warning sounds were sounded six months ago. In the case of the 2008 global financial crisis, the alert index, which was 0 until 2007, rose sharply after September 2008. However, in the case of the 2020 COVID-19 pandemic, it was analyzed that the early warning model failed to sound a warning sound in time.
Is this a crisis? I asked
It turns out that there have been five crisis situations in Korea identified by the Bank of Korea using the Compound Financial Pressure Index (CFPI) since 1997. These include the 1998 foreign exchange crisis, the 2001 IT bubble, the 2003 credit card crisis, the 2008 global financial crisis, the 2020 COVID-19 pandemic, and the 2022 Legoland incident.
As international oil prices have recently risen and the exchange rate has jumped to 1,400 won, there are concerns that another crisis may occur in the financial and foreign exchange markets. If we were to ask this early warning model, which has excellent predictive power, whether the recent situation is a crisis, what would the answer be?
Manager Park Jeong-hee responded to this question by saying, “As a result of analyzing data up to last March, the current risk index is maintained at the median level.” Manager Park explains that considering that in previous cases of market instability, such as the global financial crisis, where the risk index was in the top 10 to 30 percent, the possibility of instability occurring is not high.
In the case of the exchange rate, “It has been showing a continuous rise recently, but volatility is at a lower level compared to the second half of last year,” he said. “Because volatility is a variable included in the early warning model, the recent situation has not had a significant impact on the rise in the risk index.” explained.
The Bank of Korea plans to actively publicize the crisis situation by sharing the newly developed model with major institutions at home and abroad. Currently, the International Finance Center and others are analyzing early warning risks and informing the government.
Reporter Kang Jin-gyu [email protected]
