Information Contagion and Bank Herding
Viral V. Acharya
New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance
Federal Reserve Bank of New York
Journal of Money, Credit, and Banking, Forthcoming
We show that the likelihood of information contagion induces profit-maximizing bank owners to herd with other banks. When bank loan returns have a common systematic factor, the cost of borrowing for a bank increases when there is adverse news on other banks, since such news, in turn, conveys adverse information about the common factor. The increase in a bank's cost of borrowing relative to the situation of good news about other banks is greater when bank loan returns have less commonality (in addition to the systematic risk factor). Hence, banks herd and undertake correlated investments so as to minimize the impact of such information contagion on the expected cost of borrowing. Competitive effects such as superior margins from lending in different industries mitigate herding incentives.
Keywords: Systemic risk, Information spillover, Inter-bank correlation
JEL Classification: G21, G28, G38, E58, D62Accepted Paper Series
Date posted: October 28, 2006
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