Role of Credit in Equity Market Booms and Busts

Lillian Cheung and Chi-Sang Tam
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Lillian Cheung: Research Department, Hong Kong Monetary Authority
Chi-Sang Tam: Research Department, Hong Kong Monetary Authority

No 904, Working Papers from Hong Kong Monetary Authority

Abstract: Widespread financial distress typically arises from the unwinding of financial imbalances that build up disguised by benign economic conditions. This paper studies whether credit is a pertinent indicator of future equity price booms, and thus provides a signal for potential financial instability. Our analysis shows that excess credit does increase the probability of an equity price boom ahead. We argue that a policy response worthy of consideration would be a strengthening of the system-wide focus of the prudential framework coupled with monetary policy rules that take into account occasional development of financial imbalances to prevent potentially significant financial strains from developing. To this end, greater co-operation between monetary and prudential authorities is important, not just in managing crises, but also in preventing their emergence.

Keywords: financial stability; monetary stability; equity price booms and busts; excess credit (search for similar items in EconPapers)
JEL-codes: E51 E52 E58 G01 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2009-02
New Economics Papers: this item is included in nep-cba and nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:hkg:wpaper:0904

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