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Boundedly rational banks’ contribution to the credit cycle

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  • Rötheli, Tobias F.

Abstract

We investigate how banks’ boundedly rational learning influences their views about default risks over the business cycle. Our analysis details the direction and the magnitude of these effects assuming that banks update probability in a Bayesian way. With a limited experience span lenders are liable to overestimate (underestimate) losses from defaulting loans early (late) in the boom. Depending on their experience span, banks turn over-optimistic and underprice default risk 3–5 years into the boom. During recessions an overpricing of risk begins just quarters into the recession. Our simulations are calibrated with U.S. data and provide evidence for the view that banks contribute to excessive lending during the upswing and to credit crunches in recessions.

Suggested Citation

  • Rötheli, Tobias F., 2012. "Boundedly rational banks’ contribution to the credit cycle," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 41(5), pages 730-737.
  • Handle: RePEc:eee:soceco:v:41:y:2012:i:5:p:730-737
    DOI: 10.1016/j.socec.2012.07.005
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    References listed on IDEAS

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    More about this item

    Keywords

    Boundedly rational learning; Loan-loss expectations; Credit cycle;

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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