NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Credit Expansion and Neglected Crash Risk

Matthew Baron, Wei Xiong

NBER Working Paper No. 22695
Issued in September 2016
NBER Program(s):   AP   CF   IFM   ME

By analyzing 20 developed countries over 1920–2012, we find the following evidence of overoptimism and neglect of crash risk by bank equity investors during credit expansions: 1) bank credit expansion predicts increased bank equity crash risk, but despite the elevated crash risk, also predicts lower mean bank equity returns in subsequent one to three years; 2) conditional on bank credit expansion of a country exceeding a 95th percentile threshold, the predicted excess return for the bank equity index in subsequent three years is -37.3%; and 3) bank credit expansion is distinct from equity market sentiment captured by dividend yield and yet dividend yield and credit expansion interact with each other to make credit expansion a particularly strong predictor of lower bank equity returns when dividend yield is low.

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Document Object Identifier (DOI): 10.3386/w22695

 
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