Timing Asset Market Peaks: The Role of the Liquidity Risk Cycle of the Banking System

14 Pages Posted: 16 Jan 2012

See all articles by Patrick Weber

Patrick Weber

Frankfurt School of Finance & Management

Date Written: January 1, 2012

Abstract

Recent financial crisis showed how the unfolding of liquidity risks of financial intermediaries spilled over to asset markets, contributing to asset price deterioration and the triggering of liquidity spirals. This paper derives and tests a financial fragility condition for predicting asset price peaks on a real-time basis, by combining the term spread and the aggregate funding liquidity risks of the banking system into a simple binary fragility indicator. The main empirical result of this paper is that the fragility condition predicted all major equity market peaks in Germany during the time period 1973 to 2010, including the sub prime crisis of 2007, the New Economy Bubble of 2000, and the 1987 stock market crash. The average lead time of the indicator is 2.9 months. About 80% of the declines were later on associated with significant declines in Industrial Production.

Keywords: Liquidity Spirals, Macrofinancial Linkages, Asset Price Cycle, Liquidity Management of Financial Intermediaries, Early Warning Indicator

JEL Classification: G01, G17, E44, E51

Suggested Citation

Weber, Patrick, Timing Asset Market Peaks: The Role of the Liquidity Risk Cycle of the Banking System (January 1, 2012). Available at SSRN: https://ssrn.com/abstract=1985498 or http://dx.doi.org/10.2139/ssrn.1985498

Patrick Weber (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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