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Role of Credit in Equity Market Booms and Busts

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  • Lillian Cheung

    (Research Department, Hong Kong Monetary Authority)

  • Chi-Sang Tam

    (Research Department, Hong Kong Monetary Authority)

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    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.

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    File URL: http://www.info.gov.hk/hkma/eng/research/working/pdf/HKMAWP09_04_full.pdf
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    Bibliographic Info

    Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0904.

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    Length: 23 pages
    Date of creation: Feb 2009
    Date of revision:
    Handle: RePEc:hkg:wpaper:0904

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    Keywords: financial stability; monetary stability; equity price booms and busts; excess credit;

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    1. Takatoshi Ito, 2000. "Capital Flows in Asia," NBER Chapters, National Bureau of Economic Research, Inc, in: Capital Flows and the Emerging Economies: Theory, Evidence, and Controversies, pages 255-296 National Bureau of Economic Research, Inc.
    2. Tobias Adrian & Hyun Song Shin, 2008. "Liquidity and leverage," Staff Reports, Federal Reserve Bank of New York 328, Federal Reserve Bank of New York.
    3. Michael D. Bordo & David C. Wheelock, 2004. "Monetary Policy and Asset Prices: A Look Back at Past U.S. Stock Market Booms," NBER Working Papers 10704, National Bureau of Economic Research, Inc.
    4. Okina, Kunio & Shirakawa, Masaaki & Shiratsuka, Shigenori, 2001. "The Asset Price Bubble and Monetary Policy: Japan's Experience in the Late 1980s and the Lessons: Background Paper," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(S1), pages 395-450, February.
    5. Detken, Carsten & Smets, Frank, 2004. "Asset price booms and monetary policy," Working Paper Series, European Central Bank 0364, European Central Bank.
    6. Burkhard Drees & Ceyla Pazarbasioglu, 1995. "The Nordic Banking Crises," IMF Working Papers, International Monetary Fund 95/61, International Monetary Fund.
    7. Maria Socorro Gochoco-Bautista, 2008. "Asset prices and monetary policy: booms and fat tails in East Asia," BIS Working Papers, Bank for International Settlements 243, Bank for International Settlements.
    8. Adalid, Ramón & Detken, Carsten, 2007. "Liquidity shocks and asset price boom/bust cycles," Working Paper Series, European Central Bank 0732, European Central Bank.
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