Important Warning Indicators on Financial Crisis and Dynamic Switching of Gold Pricing Models

Abstract

In this paper, the global financial crisis which began in 2007 is divided into four stages by the switching of the leverages between financial system and governments. Gold, as one of the most important reverse calibration variables for global macro cycles, has switched its pricing models four times correspondingly.

In the first stage, from August 2007 to June 2009, with the U.S. financial system deleveraging, the gold price was running according to the three-factor model. In the second stage, accompanied by the added leverage of global governments, the gold price ran according to the U.S. real interest rate model. In the third stage, the financial market's focus shifted to the European sovereign debt crisis in February 2010, the gold price ran according to the European sovereign CDS (Credit Default Swap) model. The European countries were deleveraging in the third stage. Finally, gold turned back to the three-factor model. The trigger was the U.S. Federal Reserve's OT (Operation Twist) policy and the German Constitutional Court's legality adjudgement for the German government to aid Greece and other European countries. Both occurred in September 2011.

Further, we find that the OIS (Overnight Indexed Swap), the LIBOR-OIS spread (London InterBank Offer Rate) and the TED spread can be considered as the observation variables for the switching of the gold pricing models. These variables are usually considered as a warning to the liquidity risk of the financial institutions.

In general, gold, if not the only one, will be one of the most important assets in revealing the four stages of the financial crisis.

Keywords: gold, macro calibration, asset pricing, financial crisis

JEL Classification: E44, F31, G12