Credit Expansion and Neglected Crash Risk

55 Pages Posted: 3 Oct 2016

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: September 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.

Suggested Citation

Baron, Matthew and Xiong, Wei, Credit Expansion and Neglected Crash Risk (September 2016). NBER Working Paper No. w22695. Available at SSRN: https://ssrn.com/abstract=2846931

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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