Reflexivity in Credit Markets

Robin Greenwood, Samuel Hanson and Lawrence Jin

No 25747, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Reflexivity is the idea that investors’ biased beliefs affect market outcomes and that market outcomes in turn affect investors’ future biases. We develop a dynamic behavioral model of the credit cycle featuring this two-way feedback loop. Investors form beliefs about the likelihood of future defaults by extrapolating past defaults. Investor beliefs influence a firm’s actual creditworthiness because the firm is less likely to default in the short run when it can issue debt on favorable terms. Our model matches many features of the credit cycle, including its imperfect synchronization with the real economy and the “calm before the storm” phenomenon.

JEL-codes: G01 G40 (search for similar items in EconPapers)
Date: 2019-04
Note: AP CF
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Citations: View citations in EconPapers (11)

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