The Relation between Credit Growth and the Expected Returns of Bank Stocks
54 Pages Posted: 4 Oct 2011 Last revised: 4 May 2018
Date Written: April 17, 2018
Higher bank credit growth implies that excess returns of bank stocks over the next one year are lower by nearly 3%. Credit growth tracks bank stock returns over the business cycle and explains nearly 14% of the variation in bank stock returns over a 1-year horizon. I argue that the predictive variation in returns reflects investors' rational response to a small time-varying probability of a tail event that impacts banks and bank-dependent firms. Consistent with this hypothesis, the predictive power, as measured by the absolute magnitude of the coefficient on credit growth and the adjusted-R^2 at the 1-year horizon, depends systematically on variables that regulate exposure to tail risk.
Keywords: Bank equity returns, Tail risk, Bank credit growth
JEL Classification: G01, G02, G15, G21
Suggested Citation: Suggested Citation