Finance Discipline Group
UTS Business School
University of Technology, Sydney

Working Paper Series

Title:
Modelling the "Animal Spirits" of Bank's Lending Behaviour
Author(s): Carl Chiarella, Corrado Di Guilmi and Tianhao Zhi
Date of publication: August 2015
Working paper number: 183
Abstract:
The idea of “animal spirits” has been widely treated in the literature with particular reference to investment in the productive sector. This paper takes a different view and analyses from a theoretical perspective the role of banks’ collective behaviour in the creation of credit that, ultimately, determines the credit cycle. In particular, we propose a dynamic model to analyse how the transmission of waves of optimism and pessimism in the supply side of the credit market interacts with the business cycle. We adopt the Weidlich-Haag-Lux approach to model the opinion contagion of bankers. We test different assumptions on banks’ behaviour and find that opinion contagion and herding amongst banks play an important role in propagating the credit cycle and destabilizing the real economy. The boom phases trigger banks’ optimism that collectively lead the banks to lend excessively, thus reinforcing the credit bubble. Eventually the bubbles collapse due to an over-accumulation of debt, leading to a restrictive phase in the credit cycle.
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