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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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    File URL: http://hdl.handle.net/10.1093/qje/qjx004
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    Citations

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    Cited by:

    1. Tom Roberts, 2017. "A Counterfactual Valuation of the Stock Index as a Predictor of Crashes," Staff Working Papers 17-38, Bank of Canada.
    2. Paul, Pascal, 2017. "Historical Patterns of Inequality and Productivity around Financial Crises," Working Paper Series 2017-23, Federal Reserve Bank of San Francisco.
    3. 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.

    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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