Asset prices have long been overlooked as a powerful predictor of financial stability. In a recent analysis by Tristan Hennig, Plamen Iossifov, and Richard Varghese, they highlight the significant role that asset prices play in predicting crisis episodes [7f03be3e].
The authors introduce a new metric called the 'mispricing risk' index, which captures periods of rapid asset price growth and low asset price volatility. This index has shown to peak around one to three years prior to a crisis, making it a valuable tool for monitoring systemic risks [7f03be3e].
What sets the 'mispricing risk' index apart is its superior performance compared to traditional credit-based metrics used as early warning indicators. It offers a better trade-off between true positive and false positive rates, making it a more reliable indicator of impending crises [7f03be3e].
This research sheds light on the importance of considering asset prices when assessing financial stability. By recognizing the predictive power of asset prices, policymakers and investors can better anticipate and mitigate potential crises [7f03be3e].