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Reflexivity in Credit Markets

Author

Listed:
  • Robin Greenwood
  • Samuel G. Hanson
  • Lawrence J. Jin

Abstract

Reflexivity is the idea that investors’ biased beliefs affect market outcomes and that market outcomes in turn affect investors’ future biases. We develop a dynamic behavioral model of the credit cycle featuring this two-way feedback loop. Investors form beliefs about the likelihood of future defaults by extrapolating past defaults. Investor beliefs influence a firm’s actual creditworthiness because the firm is less likely to default in the short run when it can issue debt on favorable terms. Our model matches many features of the credit cycle, including its imperfect synchronization with the real economy and the “calm before the storm” phenomenon.

Suggested Citation

  • Robin Greenwood & Samuel G. Hanson & Lawrence J. Jin, 2019. "Reflexivity in Credit Markets," NBER Working Papers 25747, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25747
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    Cited by:

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    2. Farboodi, Maryam & Kondor, Péter, 2023. "Cleansing by tight credit: Rational cycles and endogenous lending standards," Journal of Financial Economics, Elsevier, vol. 150(1), pages 46-67.
    3. Maryam Farboodi & Péter Kondor, 2020. "Rational Sentiments and Economic Cycles," NBER Working Papers 27472, National Bureau of Economic Research, Inc.
    4. Da, Zhi & Huang, Xing & Jin, Lawrence J., 2021. "Extrapolative beliefs in the cross-section: What can we learn from the crowds?," Journal of Financial Economics, Elsevier, vol. 140(1), pages 175-196.
    5. Matthew Baron & Emil Verner & Wei Xiong, 2021. "Banking Crises Without Panics," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 136(1), pages 51-113.
    6. Liao, Gordon Y., 2020. "Credit migration and covered interest rate parity," Journal of Financial Economics, Elsevier, vol. 138(2), pages 504-525.
    7. Wang, Hailong & Hu, Duni, 2022. "Heterogenous beliefs with sentiments and asset pricing," The North American Journal of Economics and Finance, Elsevier, vol. 63(C).
    8. Adrian, Tobias & Duarte, Fernando & Liang, Nellie & Zabczyk, Pawel, 2020. "Monetary and Macroprudential Policy with Endogenous Risk," CEPR Discussion Papers 14435, C.E.P.R. Discussion Papers.

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    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G40 - Financial Economics - - Behavioral Finance - - - General

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