Predicting Financial Crises: The Role of Asset Prices

By Tristan Hennig, Plamen K Iossifov, Richard Varghese

August 4, 2023

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Tristan Hennig, Plamen K Iossifov, and Richard Varghese. Predicting Financial Crises: The Role of Asset Prices, (USA: International Monetary Fund, 2023) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We explore the early warning properties of a composite indicator which summarizes signals from a range of asset price growth and asset price volatility indicators to capture mispricing of risk in asset markets. Using a quarterly panel of 108 advanced and emerging economies over 1995-2017, we show that the combination of rapid asset price growth and low asset price volatility is a good predictor of future financial crises. Elevated levels of our indicator significantly increase the probability of entering a crisis within the next three years relative to normal times when the indicator is not elevated. The indicator outperforms credit-based early warning metrics, a result robust to prediction horizons, methodological choices, and income groups. Our results are consistent with the idea that measures based on asset prices can offer critical information about systemic risk levels to policymakers.

Subject: Asset prices, Credit, Early warning systems, Financial crises, Money, Prices, Systemic crises

Keywords: Asset price growth, Asset price volatility indicator, Asset prices, Credit, Credit metrics, Early Warning Indicator, Early warning metrics, Early warning property, Early warning systems, Financial Crises, Global, ROC, Systemic crises

Publication Details

Pages:

49
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/157
Stock No:

WPIEA2023157
ISBN:

9798400248498
ISSN:

1018-5941

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