Credit Fluctuations and 'Neglected Crash Risk' in U.S. Bank Returns

57 Pages Posted: 12 Oct 2019

See all articles by Marius Mihai

Marius Mihai

City University of New York (CUNY), The Graduate Center, Department of Economics

Date Written: September 30, 2019

Abstract

Using U.S. quarterly data from 1960, the paper studies the interaction between bank stock returns and aggregate credit fluctuations on a set of economic dimensions. First, I investigate the source of "Neglected Crash Risk" in U.S. bank returns using a new deviation measure of aggregate loans per capita called ltd. A one standard deviation increase in ltd decreases bank stock returns by 5%, and their dividend growth by almost 6% over the following year. This variable embeds important information about both future returns (discount rate news) and cash flow growth (dividend news); yet a decomposition of future unexpected bank returns shows a higher incremental effect associated with the variance of news about the discount rate. Second, I quantify the size of "Neglected Crash Risk" and find it is economically and statistically significant at different forecast horizons and for different degrees of credit boom intensity. I interpret its size as the outcome of differences in perceived disaster probabilities by investors across credit regimes. Lastly, changes in monetary policy activate crash risk in the perception of commercial bank investors. A straightforward application of the local-projection methods of Jorda (2005) illustrates that a contractionary-type monetary policy action decreases bank returns more when the economy had experienced credit booms in the past.

Keywords: Credit Growth, Bank Stock Returns, Business Cycles, Monetary Policy

JEL Classification: G21, G17, E51

Suggested Citation

Mihai, Marius, Credit Fluctuations and 'Neglected Crash Risk' in U.S. Bank Returns (September 30, 2019). Available at SSRN: https://ssrn.com/abstract=3462620 or http://dx.doi.org/10.2139/ssrn.3462620

Marius Mihai (Contact Author)

City University of New York (CUNY), The Graduate Center, Department of Economics ( email )

365 Fifth Avenue, 5th Floor
New York, NY 10016
United States

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