The Expectations Driven Financial Accelerator

55 Pages Posted: 17 Oct 2019

See all articles by Antonio Falato

Antonio Falato

Board of Governors of the Federal Reserve System

Jasmine Xiao

University of Notre Dame - Department of Economics

Date Written: October 7, 2019

Abstract

This paper develops a unified quantitative account of credit cycles and their macroeconomic consequences based on information frictions in debt markets. Using a dynamic model with endogenous default, we highlight a novel “herding” mechanism whereby uninformed debt investors learn about firms’ creditworthiness from publicly-available survey information on quarter-ahead corporate profits. We show that: 1) short-term changes in expectations of corporate profits strongly forecast credit spreads and real economic aggregates over up to two years horizons; 2) credit spreads and defaults are counter-cyclical; 3) the mechanism can account quantitatively for the historically large spike in spreads during the financial crisis.

Keywords: expectations, survey forecasts, bond pricing, business cycles

JEL Classification: D84, G12, G30, E32

Suggested Citation

Falato, Antonio and Xiao, Jasmine, The Expectations Driven Financial Accelerator (October 7, 2019). Available at SSRN: https://ssrn.com/abstract=3465336 or http://dx.doi.org/10.2139/ssrn.3465336

Antonio Falato (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

Jasmine Xiao

University of Notre Dame - Department of Economics ( email )

Notre Dame, IN 46556
United States

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