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  • 2021
  • Working Paper

Real Credit Cycles

By: Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer and Stephen J. Terry
  • Format:Print
  • | Language:English
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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 U.S. 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.

Keywords

Econometric Models; Business Cycles; Credit

Citation

Bordalo, Pedro, Nicola Gennaioli, Andrei Shleifer, and Stephen J. Terry. "Real Credit Cycles." NBER Working Paper Series, No. 28416, January 2021.
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About The Author

Andrei Shleifer

Negotiation, Organizations & Markets
→More Publications

More from the Authors

    • April 2022
    • Journal of Finance

    Predictable Financial Crises

    By: Robin Greenwood, Samuel G. Hanson, Andrei Shleifer and Jakob Ahm Sørensen
    • September 2021
    • Journal of Financial Economics

    Diagnostic Bubbles

    By: Pedro Bordalo, Nicola Gennaioli, Spencer Yongwook Kwon and Andrei Shleifer
    • 2021
    • Faculty Research

    Salience

    By: Pedro Bordalo, Nicola Gennaioli and Andrei Shleifer
More from the Authors
  • Predictable Financial Crises By: Robin Greenwood, Samuel G. Hanson, Andrei Shleifer and Jakob Ahm Sørensen
  • Diagnostic Bubbles By: Pedro Bordalo, Nicola Gennaioli, Spencer Yongwook Kwon and Andrei Shleifer
  • Salience By: Pedro Bordalo, Nicola Gennaioli and Andrei Shleifer
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