Credit Expansion and Neglected Crash Risk

In this paper I examine the effects credit expansion has on bank equity and whether bank shareholders recognise the increased crash risk that comes with credit expansion. This is done through five regressions, each of which answers a specific element of this question. First I found that credit expansion actually increased the crash risk of bank equity. The second regression showed that bank shareholders do not demand higher returns given the increased crash risk when credit expansion was high, but rather receive lower returns. A third regression aimed to distinguish whether these lower returns were the result of elevated risk appetite or actually neglected crash risk and proved the latter to be the case. A fourth regression gave insight on the particular sentiment associated with credit expansion, yielding that it is different from the sentiment associated with the market. Lastly I analysed the effect of credit expansion on volatility, which yielded no significant results.