Reflexivity in Credit Markets

73 Pages Posted: 12 Jan 2024

See all articles by Robin M. Greenwood

Robin M. Greenwood

Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)

Samuel Gregory Hanson

Harvard University - Business School (HBS)

Lawrence J. Jin

SC Johnson College of Business, Cornell University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 22, 2023

Abstract

Reflexivity is the idea that investors' biased beliefs affect market outcomes and that market outcomes in turn affect investors' future biases. We develop a dynamic behavioral model of the credit cycle featuring this two-way feedback loop. Investors form beliefs about the likelihood of future defaults by extrapolating past defaults. Investor beliefs influence a firm’s actual creditworthiness because the firm is less likely to default in the short run when it can issue debt on favorable terms. Our model matches many features of the credit cycle, including its imperfect synchronization with the real economy and the "calm before the storm" phenomenon.

Keywords: reflexivity, default extrapolation, return predictability

JEL Classification: G02, G11, G12

Suggested Citation

Greenwood, Robin M. and Hanson, Samuel Gregory and Jin, Lawrence J., Reflexivity in Credit Markets (December 22, 2023). Available at SSRN: https://ssrn.com/abstract=4673867 or http://dx.doi.org/10.2139/ssrn.4673867

Robin M. Greenwood

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6979 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Samuel Gregory Hanson

Harvard University - Business School (HBS) ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

Lawrence J. Jin (Contact Author)

SC Johnson College of Business, Cornell University ( email )

310E Warren Hall
Ithaca, NY 14850
United States
607-255-0581 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
408
Abstract Views
1,410
Rank
124,933
PlumX Metrics