A Dynamic Behavioral Model of the Credit Boom

David Peón, Manel Antelo and Anxo Calvo

Journal of Economic Issues, 2015, vol. 49, issue 4, 1077-1099

Abstract: We provide a dynamic model of banking competition, in which bounded rationality of some competitors explains how the credit cycle is intensified. We model the economic cycle following Tobias F. Rötheli (2012b), who argues that boundedly rational banks, in their Bayesian learning, overestimate the probability of success during booms and underestimate it during recessions. We obtain three main results. First, the model suggests that pessimism/underconfidence is not a powerful driver of credit cycles. Instead, it supports the conclusion that it is euphoria during large upswings that leads to the next crunch. Second, the dynamization of the model provides further insight into the way boundedly rational competition intensifies the credit cycle. Third, it additionally predicts that the effects of behavioral biases are more pervasive when the quality of the niche markets is lower.

Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:mes:jeciss:v:49:y:2015:i:4:p:1077-1099

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DOI: 10.1080/00213624.2015.1105043

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