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Predicting Financial Crises: The Role of Asset Prices

Tristan Hennig, Plamen Iossifov and Richard Varghese

No 2023/157, IMF Working Papers from International Monetary Fund

Abstract: 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.

Keywords: Early Warning Indicator; ROC; Financial Crises; asset price volatility indicator; early warning property; asset price growth; early warning metrics; credit metrics; Asset prices; Early warning systems; Credit; Systemic crises; Global (search for similar items in EconPapers)
Pages: 49
Date: 2023-08-04
New Economics Papers: this item is included in nep-ban, nep-fdg, nep-fmk and nep-rmg
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