Beyond Bubbles: The Role of Asset Prices in Early-Warning Indicators

Asset prices have recently become a common topicin economic debate. Nevertheless, much time hasbeen spent in determining if they effectively exhibita bubble component, and not in examining whetherasset prices contain relevant information concerningfuture market developments. This paper is aneffort in this direction, aimed towards the constructionof early-warning indicators for Colombia usingfinancial and real variables. Results show evidenceto support that there is relevant information embeddedin these series, as all indicators (except the newhousing price indicator) show a significant deviationfor the year(s) prior to the 98-99 crisis. Additionally,the exercises here conducted show that theperformance of asset price indicators is enhancedby including credit and investment. When the early-warning indicators are on, the role of the policymaker should be more active in the market; notnecessarily in terms of altering interest rates, butin communicating with market agents, promotingportfolio diversification and urging financial agentsto make the best use of the risk-management toolsthat are available to them.Asset Price Bubbles, Early-WarningIndicators, Financial Crisis, Prudential Regulation.