Finance Seminar: Janet Gao

Overreaction in Credit Spreads: The Role of Lenders' Personal Economic Experiences

Janet Gao, Kelley School of Business, Indiana University

We provide micro-level evidence that credit spreads overreact to lenders’ recent personal economic experiences. Using unique data on the location of the real estate properties of loan officers in charge of large corporate loans, we show that credit spreads overweight recent economic conditions in officers’ local neighborhoods, that we capture using local housing price growth. Higher local growth in officers’ areas is associated with significantly lower credit spreads. The analysis suggests that these effects cannot be explained by borrower and bank fundamentals, or wealth effects, and that they capture officers’ responses to their recent economic experiences. Overall, the evidence is mostly consistent with the view that our results are driven by an overreaction in officers’ beliefs to their recent economic experiences.
(joint with Daniel Carvalho, Janet Gao, and Pengfei Ma)