Charge-offs, Defaults and U.S. Business Cycles

50 Pages Posted: 14 Jul 2019

See all articles by Christopher Gunn

Christopher Gunn

Carleton University - Department of Economics

Alok Johri

McMaster University - Department of Economics

Marc-André Letendre

McMaster University - Department of Economics

Date Written: July 12, 2019

Abstract

We uncover a new fact: U.S. banks counter-cyclically vary the ratio of charge-offs to defaulted loans. The variance of this ratio is roughly 15 times larger than that of GDP. Canonical financial accelerator models cannot explain this variance. We show that introducing stochastic default costs into the model helps to resolve the discrepancy with the data. Estimating the augmented model using Bayesian techniques reveals that the estimated default cost shocks not only help account for the variance of the banking data but also help account for a significant fraction of the U.S. business cycle between 1984 and 2015.

Keywords: charge-offs and defaults, default cost shocks, financial accelerator models, business cycles

JEL Classification: E3, E44

Suggested Citation

Gunn, Christopher and Johri, Alok and Letendre, Marc-Andre, Charge-offs, Defaults and U.S. Business Cycles (July 12, 2019). Available at SSRN: https://ssrn.com/abstract=3419100 or http://dx.doi.org/10.2139/ssrn.3419100

Christopher Gunn

Carleton University - Department of Economics ( email )

1125 Colonel By Drive
Ottawa, Ontario K1S 5B6
Canada

Alok Johri

McMaster University - Department of Economics ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada

Marc-Andre Letendre (Contact Author)

McMaster University - Department of Economics ( email )

1280 Main Street W
Hamilton, Ontario L8S 4M4
Canada

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