Credit Expansion and Neglected Crash Risk

91 Pages Posted: 26 Jan 2017

See all articles by Matthew Baron

Matthew Baron

Cornell University - Samuel Curtis Johnson Graduate School of Management

Wei Xiong

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: October 14, 2016

Abstract

By analyzing 20 developed countries over 1920–2012, we find the following evidence of overoptimism and neglect of crash risk by bank equity investors during credit expansions: 1) 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; 2) 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 3) 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.

Keywords: Credit Expansion, Financial Crises

JEL Classification: G01, G02, G15, G21

Suggested Citation

Baron, Matthew and Xiong, Wei, Credit Expansion and Neglected Crash Risk (October 14, 2016). Available at SSRN: https://ssrn.com/abstract=2906119 or http://dx.doi.org/10.2139/ssrn.2906119

Matthew Baron (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

Wei Xiong

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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