Real Credit Cycles

68 Pages Posted: 1 Feb 2021 Last revised: 21 Feb 2022

See all articles by Pedro Bordalo

Pedro Bordalo

University of Oxford - Said Business School

Nicola Gennaioli

Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Stephen Terry

Boston University; National Bureau of Economic Research

Date Written: January 2021

Abstract

We incorporate diagnostic expectations into a workhorse neoclassical business cycle model with heterogeneous firms and risky debt. A realistic degree of diagnostic overreaction estimated from US firm forecasts generates economic fragility during good times, countercyclical credit spreads, and boom-bust credit cycles at the firm and aggregate levels. Good times predict future disappointment, spread increases, low bond returns, and investment declines. To generate the size of spread increases observed during 2008-9, the model requires only disappointment of overoptimistic beliefs rather than large negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.

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Suggested Citation

Bordalo, Pedro and Gennaioli, Nicola and Shleifer, Andrei and Terry, Stephen, Real Credit Cycles (January 2021). NBER Working Paper No. w28416, Available at SSRN: https://ssrn.com/abstract=3776984

Pedro Bordalo (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

Nicola Gennaioli

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Andrei Shleifer

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-5046 (Phone)
617-496-1708 (Fax)

HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

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European Corporate Governance Institute (ECGI)

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1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Stephen Terry

Boston University ( email )

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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