Investment industry has under gone a series of changes over the last decade among the changes that have occurred during this period is the regulatory change. Since the financial crisis the finance regulators have focused on the market as a whole and among the areas that have been focused include the over the counter derivatives, and the hedge funds. The central bank needs to think about filling the vacuum to prevent the economy from crushing.
As a result, of increase in regulation in the financial markets, regulators are concerned about the role of investment managers and financial stability. Moreover, the financial regulators such as the International Monetary Fund and the Bank of International Settlement together with the financial stability board they have increased concern about the increase of the asset management and investment managers. They are concern that these could result to increase in out flow from one class of asset during financial crisis thus worsening the situation (Kemna, 2015). These bodies are calling for strong micro prudence supervision and increase in general oversight of the asset management. This will include ensuring that there is improved risk indication and the industry is forcefully supervised to meet the global standards. Never the other issue that is of concern is how the asset managers are remunerated. It is said that their remuneration impacts systemic risk thus contributing to factors to price bubbles which is a major cause of inflated equity and bonds in markets. This paper will discuss about the evolution of asset prices considering the current regulatory environment.
In the asset price bubble where it involves movement of microeconomic fundamentals it will be known as normal bubble. However, if the asset price is concern of the asset development which deviates from the macroeconomics then this is known as the price bubble. In comparison of the normal bubble and the price bubble, the price movement in market is considered to be more dangerous and in such situation. It is even more complicated because it calls for monetary policy intervention (Kemna, 2015).
The situation of pricing of assets in the monetary policies by the central bank is important in asset price stability. On the long term, asset prices are influenced by real factors such as productivity, Demographic influence and society preference. The central bank encounters numerous challenges while trying to influence the above factors. Moreover, it is more difficult for the regulating authority to target the asset prices. On the other side, the asset prices are of great help to the central bank because they act as indicators of expected future development. More often, asset prices provide the central with essential information which is linked with future development of risk and price stability. With indications from asset prices, the central bank is able to act upon any pressure that might destabilize the economy. For instance, the growth of asset prices may be a signal to rise in inflation; although, at times it is not be the case (Kemna, 2015). Likewise, it is important to discover the nature of stocks that bring change in pricing of assets because and because these economic shocks act as a spur to asset price growth where it does not concur then this will result to higher inflation.
The Rationale behind Asset Price Formation and Speculation
Asset prices are catalyzed by the investors expectations which is, as a result, of future economic development. If investors expectations are high on economic development it is likely that present value of future assets will be affected. These will cause change in long term expectations thus affecting future development of the economy. A change in economic fundamentals such as tax policies, interest rates and prices inputs is likely to cause change to the entire economic activity.
The Harmful Price Bubble
Price asset speculation is what results to increase in asset prices, the expectations of investors speculation is founded on the assumptions of increase in inflation and from that there is a resultant in depreciation due to growth in prices of assets. Such circumstances give value of providing loans that will decrease leading to commotion in asset markets and to the developing of price bubble. The influence of increase in asset prices the rate of borrowing on households and firms is made easier. This happens because the risk of borrowing is considered to be low in consequence the rate of investments rise in value because the value of investment is overvalued (Moore, 2016). As a result, issues of stock over valuation begin to arise which lead to disrupting the balance of economy thus leading to a financial crisis. Besides, the negative effects that are witnessed on the financial sector, more damages are done to the overall economy, as a result, of speculation.
A downfall in prices of asset s is likely to negatively impact the development of the economy this is because the government would opt to borrow rather than raise taxes which would be very demanding. Borrowing would increase the public debt and at the same time increase the interest rates. From the outlined facts it is true that speculative expectations are very dangerous because they can destabilize the market and trigger turbulence on the financial markets (Moore, 2016).
Classification of Asset Prices
Asset prices are sometimes classified according effects they have on the economy. High cost asset price boom are accompanied by the growth in real income as well as increase in investments and more so on investment on housing. The period after the boom is recession; this period is mostly characterized by a sharp fall in real in prices of goods and service this causes off high cost boom. The cause for the boom and recession in asset prices is because of susceptibility of financial institutions.
Bubble Effect in U.S. Home Prices
A bubble exists because of the belief that prices are high and the fact that investors believe that in the future the selling price will increase, even though these factors cannot be justified. However, most people view the rapid growth in national price as a prime face because such increases may be necessary but not sufficient. Therefore, there is need for more additional sufficient evidence that relates present-day home prices as major so that claims against the bubble can be justified. The following are measures used to support bubble claims and determine whether, home prices are comparative to the income of households (Philosophical Economics, 2013). The ratio of median home price is chosen as the best measure of home affordability, higher median ratios are an indication of the high cost of owning a house because of high mortgage rates. This causes a downward pressure for homes which results into reduction in demand. The second method of evaluating homes is through price fundamentals this is compared with the implicit rent that home owner will receive from home ownership. If the rent ratio is low it shows that the rate of return on the housing sector is low compared to other assets. Therefore, it would take long for the price to rise to the same level compared with the other assets and probably at this time home prices will have fallen.
Central bank policy at price stability
Arising Conflicts between the Central Bank and Stability Price
The main mandate of the central bank is to maintain stabilize prices in the economy the regulator uses interests rates as their major tool. The change in interest rates will have an impact on the level of consumption and as a result, influence the asset prices. Maintaining a stable price in the economy is vital because it decreases rate of speculation. However, a short term conflict can occur between price speculation and fiscal stability. If change prices of assets occur as a result of projection in future in such cases the central bank can correct the situation by tightening of monetary policies (Philosophical Economics, 2013). Nevertheless, predicting the development in asset market provides an important element of wealth.
Possible Measures That Central Bank Can Take In Case of a Price Bubble
The issue of asset prices is not provided for by the regulator when it happens and therefore, when this issue arises it is appropriate the central bank to take quick measures and correct the situation. However, the most appropriate measure for the regulator is aimed at eliminating the inflation in the economy thus maintains price stability. If there is a rise in price of assets monetary policies should be tightened this is done by increasing the interest rates. These reactions will only have short consequences in inflation reduction and therefore, the economy should avoid macroeconomic disequilibrium over the medium term. This can be done by capturing such potentials which are longer than one year. According to various studies they propose that the best way to limit the impact of price bubble on the economy is by adopting the interest rates to the movement of the assets.
Preparing For the Next Stock Crunch
Historically Equity investments have been considered to be a great investment and there is no reason for that to change even in the future this is because of their high returns. However, this is not always the case, at times investors experiences losses due to declines which may arise occasionally. A large percentage of investors shy away from investing in equities because of the risks associated with; however, to some they need to access their money in the short term and because of that they are not willing to invest their money in portfolios that will take long for them to get the returns.
Stock decline is not the same; markets can fall because of economic factors such as inflation which will cause decline in economic growth. A decline can also be caused by political crisis as well as shocks to the financial markets. Each of these causes requires a different solution, it is important to take a quick action before crashing of the markets. The first measure would be to diversify in the number of portfolios to invest in. For instance it would not be advisable to invest just in the US markets; this would help avoid what happened in 2008. As, an investors, it would be much safe if one hold other stocks in other countries that have potential of smooth returns. The other precaution that one would take is the issue of market timing; this is very important considering the fact that data on historical equity performance is inclusive of crashes.
In most cases stock decline are not predictable, however, there are other declines which happen out of leadership knowledge and this calls for market regulations. Market on long-term investment is viewed to be very complex because of variety of products traded, it is also difficult to quantify. In long-term investments rules are classified as either having a direct impact or an adverse impact. Rules that regulate other financial markets are likely to have an impact on the long term investments. This impact can result into the following outcomes:
This is the first outcome regarding the covered bonds; it is a direct way of creating a positive impact. These Bonds are backed up by a specific rule; therefore, it is upon the regulators and investors to create a common ground and come up with ways to formulate the standards. For instance the regulators should develop a common standard for accounting for bonds and treatment of residual debt. Moreover, green bonds should be supported to help avoid the risk that may arise (Philosophical Economics, 2013). Another area that is of concern is on the real estate the proposed solution for this long term investment is to introduce the EU trust which w...
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