The Rodney L. White Center for Financial Research Bank Credit Cycles

Private information about prospective borrowers produced by a bank can affect rival lenders due to a "winner’s curse" effect. Strategic interaction between banks with respect to the intensity of costly information production results in endogenous credit cycles, periodic "credit crunches." Empirical tests are constructed based on parameterizing public information about relative bank performance that is at the root of banks’ beliefs about rival banks’ behavior. Consistent with the theory, we find that the relative performance of rival banks has predictive power for subsequent lending in the credit card market, where we can identify the main competitors. At the macroeconomic level, we show that the relative bank performance of commercial and industrial loans is an autonomous source of macroeconomic fluctuations. We also find that the relative bank performance is a priced risk factor for both banks and nonfinancial firms. The factor-coefficients for nonfinancial firms are decreasing with size. We thank Steve Davis, Armando Gomes, Charles Kahn, Anil Kashyap, Richard Kihlstrom, Narayana Kocherlakota, George Mailath, Ben Polak, Eric Rosengren, Geert Rouwenhorst, Nick Souleles, Jeremy Stein and seminar participants at Duke, Chicago, Moody’s Investors Services, Yale, and the NBER Conference on Capital Markets and the Economy for their comments and suggestions. Philadelphia, PA 19104-6367. Phone: (215) 898-4802. E-mail: [email protected]. 601 South Morgan, Chicago, IL 60607; Phone: (312) 413-9142. E-mail: [email protected].