Year: 2019
Type: report
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. These 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.
DOI: 10.3386/w25747
Institutions: University of North Carolina at Chapel Hill, California Institute of Technology, National Bureau of Economic Research, Harvard University, Federal Reserve Bank of San Francisco, University of Washington, University of Massachusetts Amherst, University of Michigan, University of Oxford, London Business School, Brandeis University, Columbia University, Cornell University
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
Funder: Harvard Business School
OpenAlex ID: W2899561968