Credit Expansion and Neglected Crash Risk

Matthew Baron and Wei Xiong

The Quarterly Journal of Economics, 2017, vol. 132, issue 2, 713-764

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.

JEL-codes: G01 G02 G15 G21 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (118)

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