Real Credit Cycles / Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer, Stephen J. Terry.

By:

Bordalo, Pedro

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w28416.Publication details: Cambridge, Mass. National Bureau of Economic Research 2021.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We incorporate diagnostic expectations, a psychologically founded model of overreaction to news, into a workhorse business cycle model with heterogeneous firms and risky debt. A realistic degree of diagnosticity, estimated from the forecast errors of managers of US listed firms, creates financial fragility during good times. This mechanism produces countercyclical credit spreads and yields two key features of observed credit cycles. First, it generates boom-bust dynamics at the firm and aggregate levels: cheap credit predicts future increases in spreads, low bond returns, and investment drops. Second, it produces the spike in spreads observed in 2008-9 from modest negative TFP shocks. Diagnostic expectations offer a parsimonious mechanism generating realistic financial reversals in conventional business cycle models.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w28416 (Browse shelf(Opens below))	Not For Loan

Total holds: 0

January 2021.

We incorporate diagnostic expectations, a psychologically founded model of overreaction to news, into a workhorse business cycle model with heterogeneous firms and risky debt. A realistic degree of diagnosticity, estimated from the forecast errors of managers of US listed firms, creates financial fragility during good times. This mechanism produces countercyclical credit spreads and yields two key features of observed credit cycles. First, it generates boom-bust dynamics at the firm and aggregate levels: cheap credit predicts future increases in spreads, low bond returns, and investment drops. Second, it produces the spike in spreads observed in 2008-9 from modest negative TFP shocks. Diagnostic expectations offer a parsimonious mechanism generating realistic financial reversals in conventional business cycle models.