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Credit Expansion and Neglected Crash Risk

Listed author(s):
  • Matthew Baron
  • Wei Xiong
Registered author(s):

    By analyzing 20 developed economies over 1920–2012, we find the following evidence of overoptimism and neglect of crash risk by bank equity investors during credit expansions: (i) bank credit expansion predicts increased bank equity crash risk, but despite the elevated crash risk, also predicts lower mean bank equity returns in subsequent one to three years; (ii) conditional on bank credit expansion of a country exceeding a 95th percentile threshold, the predicted excess return for the bank equity index in subsequent three years is −37.3%; and (iii) bank credit expansion is distinct from equity market sentiment captured by dividend yield and yet dividend yield and credit expansion interact with each other to make credit expansion a particularly strong predictor of lower bank equity returns when dividend yield is low.

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    File URL: http://hdl.handle.net/10.1093/qje/qjx004
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    Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

    Volume (Year): 132 (2017)
    Issue (Month): 2 ()
    Pages: 713-764

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    Handle: RePEc:oup:qjecon:v:132:y:2017:i:2:p:713-764.
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