Credit Cycles, Expectations, and Corporate Investment.

This article empirically tests the Minsky hypothesis, which posits that business fluctuations arise from irrational swings in expectations. Using predictable firm-level forecast errors of long-term earnings growth, the authors construct an aggregate index of irrational expectations that strongly predicts credit market sentiment (CMS) and subsequent boom-bust cycles in corporate credit issuance and investment. Their findings show that both financially constrained and unconstrained firms exhibit similar cyclical patterns in debt issuance and investment driven by these irrational expectations, indicating that overoptimism affects both the supply of capital by investors and the demand for capital by managers. The authors rationalize these results within a dynamic Q-theory model incorporating risky debt and diagnostic (biased) expectations held by both managers and credit investors, highlighting the role of biased beliefs in amplifying credit and business cycles beyond what financial frictions alone can explain.