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Credit Expansion and Neglected Crash Risk

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  • Matthew Baron
  • Wei Xiong

Abstract

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.

Suggested Citation

  • Matthew Baron & Wei Xiong, 2017. "Credit Expansion and Neglected Crash Risk," The Quarterly Journal of Economics, Oxford University Press, vol. 132(2), pages 713-764.
  • Handle: RePEc:oup:qjecon:v:132:y:2017:i:2:p:713-764.
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    Cited by:

    1. De Santis, Roberto A., 2016. "Credit spreads, economic activity and fragmentation," Working Paper Series 1930, European Central Bank.
    2. Pedro Bordalo & Nicola Gennaioli & Andrei Shleifer, "undated". "Diagnostic Expectations and Credit Cycles," Working Paper 350646, Harvard University OpenScholar.
    3. Tom Roberts, 2017. "A Counterfactual Valuation of the Stock Index as a Predictor of Crashes," Staff Working Papers 17-38, Bank of Canada.
    4. David López-Salido & Jeremy C. Stein & Egon Zakrajšek, 2017. "Credit-Market Sentiment and the Business Cycle," The Quarterly Journal of Economics, Oxford University Press, vol. 132(3), pages 1373-1426.
    5. Christopher Hansman & Harrison Hong & Wenxi Jiang & Yu-Jane Liu & Juan-Juan Meng, 2018. "Riding the Credit Boom," NBER Working Papers 24586, National Bureau of Economic Research, Inc.
    6. Jen-Wen Chang & Simpson Zhang, 2018. "Competitive Pay and Excessive Manager Risk-taking," Working Papers 18-02, Office of Financial Research, US Department of the Treasury.
    7. Atif Mian & Amir Sufi & Emil Verner, 2017. "Household Debt and Business Cycles Worldwide," The Quarterly Journal of Economics, Oxford University Press, vol. 132(4), pages 1755-1817.
    8. Gehrig, Thomas Paul & Iannino, Maria Chiara, 2016. "Did the Basel Process of Capital Regulation Enhance the Resiliency of European Banks?," Annual Conference 2016 (Augsburg): Demographic Change 145743, Verein für Socialpolitik / German Economic Association.
    9. Gandhi, Priyank & Lustig, Hanno & Plazzi, Alberto, 2016. "Equity Is Cheap for Large Financial Institutions: The International Evidence," Research Papers 3454, Stanford University, Graduate School of Business.
    10. Alan Moreira & Alexi Savov, 2014. "The Macroeconomics of Shadow Banking," NBER Working Papers 20335, National Bureau of Economic Research, Inc.
    11. Basak, Deepal & Murray, Alexander & Zhao, Yunhui, 2017. "Does Financial Tranquility Call for More Stringent Regulation?," MPRA Paper 81373, University Library of Munich, Germany.
    12. repec:spr:decfin:v:41:y:2018:i:1:d:10.1007_s10203-018-0205-4 is not listed on IDEAS
    13. Paul, Pascal, 2017. "Historical Patterns of Inequality and Productivity around Financial Crises," Working Paper Series 2017-23, Federal Reserve Bank of San Francisco.
    14. repec:eee:ecmode:v:67:y:2017:i:c:p:392-408 is not listed on IDEAS
    15. João F. Gomes & Marco Grotteria & Jessica A. Wachter, 2017. "Cyclical Dispersion in Expected Defaults," NBER Working Papers 23704, National Bureau of Economic Research, Inc.
    16. Atif R. Mian & Amir Sufi, 2018. "Finance and Business Cycles: The Credit-Driven Household Demand Channel," NBER Working Papers 24322, National Bureau of Economic Research, Inc.
    17. Jules H. van Binsbergen & Christian C. Opp, 2017. "Real Anomalies," NBER Working Papers 23238, National Bureau of Economic Research, Inc.
    18. Atif Mian & Amir Sufi & Emil Verner, 2017. "How do Credit Supply Shocks Affect the Real Economy? Evidence from the United States in the 1980s," NBER Working Papers 23802, National Bureau of Economic Research, Inc.

    More about this item

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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