Countercyclical Behavior Research Articles

The role of diversification in stabilizing bank credit over the business cycle

AbstractWe investigate whether diversification stabilizes bank lending cyclicality on a sample of 25 conventional and 18 Islamic banks from Malaysia spanning 2008 to 2021. Our findings reveal that both bank types are nonlinearly procyclical during economic expansions, with Islamic banks also exhibiting countercyclical behavior during economic contractions. Diversification is positively associated with credit growth in conventional banks and Islamic bank subsidiaries, and it amplifies procyclicality across all Islamic bank types. Conversely, loan concentration stabilizes credit in Islamic banks. These results are robust to an alternative credit measure. Further analyses indicate that public and foreign banks are procyclical during booms and countercyclical during busts. At the same time, diversification heightens procyclicality in private, local, and foreign banks, whereas concentration mitigates it in public and local banks.

Heterogeneous impact of economic and political uncertainty on green bond volatility: Evidence from the MRS-GARCH-MIDAS-Skewed T model

Green bonds attract increasing attention as a new eco-friendly investment product. We explore the heterogeneous impact of low-frequency economic and political uncertainty across high or low uncertainty states on green bond volatility in order to accurately analyze the green bond market risk. To this end, we propose a new Markov regime switching GARCH-MIDAS-Skewed T model, in which the regime switching behavior occurs on the low-frequency long-term volatility. An effective filtering estimation method is put forth by introducing the likelihood of the low-frequency sub-sample set. The evidence supports that there are significant time-varying and state-dependent impacts from uncertainty shocks on the volatility of green bonds, including monetary policy, inflation, and crude oil prices as well as global economic policy and political environment. In addition, we find the counter-cyclical behavior of green bond volatility, which increases in the period of economic recession or financial turbulence with expanding uncertainty. Improving the hedging ability of green bonds against uncertainty risks effectively contributes to low-carbon economic development.

Islamic bank procyclicality in an emerging market economy: Do bank size and financing contracts matter?

Using a sample of Islamic banks in Indonesia, our empirical findings demonstrate a positive relationship between economic growth and financing growth in Islamic banks, indicating procyclical behavior. However, the degree of procyclicality varies depending on bank size, with small banks exhibiting a more pronounced procyclical behavior compared to large banks, which display a countercyclical pattern. Our deeper analysis reveals that consumption financing contracts through Murabahah and Istisna contribute to the countercyclical behavior observed in large Islamic banks. Moreover, Musharakah as a productive financing contract does not exhibit procyclical behavior regardless of bank size. In contrast, another productive financing contract, Mudharabah, can lead large Islamic banks to behave countercyclically. Additionally, Ijarah, a leasing contract used for either consumption or productive purposes, exhibits a procyclical pattern in large Islamic banks, indicating that it cannot serve as a hedge during economic downturns for these banks. Overall, these results underscore the importance of Islamic bank consolidation, as large Islamic banks tend to effectively overcome procyclicality throughout the business cycle by utilizing the majority of financing contracts.

Evaluating Fiscal Policy Under Cyclical Balance in Developed Countries

Abstract This study investigates the cyclical patterns of fiscal policy rules using various policy variables that respond to the macroeconomic performance of developed countries over the past few decades. The study reveals that regardless of whether the economy is in a recession or a boom, fiscal policy basically displays counter-cyclical behavior. However, the degree of cyclicality varies depending on the output gap measurements chosen and the countries analyzed. Additionally, the estimates using various fiscal policy indicators demonstrate a strong time variation in fiscal cyclical behavior, resulting in a significant increase in the counter-cyclicality of the fiscal balance. The article also applies the time-varying coefficients vector autoregression model to assess the effects of fiscal policy on output and finds that a boost in the cyclically adjusted primary balance positively impacts production in the short run.

Are sharia bank financings in Indonesia procyclical?

Purpose – The study aims to determine whether Islamic banks' debt financing and equity financing are procyclical or counter-cyclical.Methodology – The data used in this study cover eight Islamic commercial banks and span from 2008 to 2020, thereby including 72 observations. The analysis employs the dynamic panel data model estimated using the GMM method (Generalized Method of Moments).Findings –The debt-based financing, under murabahah, salam, istishna, and ijarah contracts, did not display clear procyclical or counter-cyclical behavior. In contrast, equity financing based on mudharabah and musyarakah contracts demonstrated procyclical characteristics concerning economic fluctuation.Implications – Policymakers need to pay more attention to Islamic banks with a greater proportion of equity financing for both micro and macroprudential policy purposes since procyclicality is likely to be associated with higher risks. Similarly, Islamic banks with greater proportion of equity financing need to watch carefully the behavior of their equity financing concerning its effect on risks for the purpose of their risk management and prudential policy. Originality – This research paper fills in the absence of studies that examine which category of Islamic bank financing – debt-based or equity-based financing - is more procyclical.

Braking before the curve and accelerating inside? Exploration, countercyclical behavior, and SMEs’ resilience during economic downturns

Some studies have provided empirical evidence that firms’ high growth rates just before economic crises are negatively associated with resilience. Other authors have observed that firms that grow fast in the early phases of an external crisis are generally more resilient. This countercyclical behavior is less common in small- and medium-sized enterprises (SMEs), and literature has not delved into the underlying factors that facilitate SMEs’ countercyclical strategies. Firm exploration is defined as a firm’s willingness to experiment, take risks, be flexible, and accept variation. Our thesis is that exploration acts as a countercyclical factor by slowing down a firm’s growth before the external shock takes effect, favoring growth during the crisis, and providing better resilience outcomes. We find support for our hypotheses from a sample of 2,081 manufacturing medium-sized enterprises.Jel Classification: M10 GENERAL

Firm informality during the COVID-19 crisis in Argentina: perception of commercial entrepreneurs and public accountants

This article analyzes the impact of the COVID-19 crisis on the informality of Argentinian micro-, small-, and medium-sized enterprises based on the perception of commercial entrepreneurs and public accountants from Bahía Blanca (Argentina). Using primary data collected through semi-structured interviews, a qualitative content analysis was performed combining theory-oriented and data-based coding. Despite the widespread use of electronic payments, the findings suggest an increase in income underreporting and the number of unregistered companies, thus supporting the countercyclical behavior of the informal sector during that crisis. The article contributes to a better understanding of informality through a microeconomic-qualitative approach by integrating the perspective of two different actors. Empirical findings are relevant for policymakers seeking to reduce the levels of informality during periods of crisis.

Predicting Bond Return Predictability

This paper provides empirical evidence on predictable time variations in out-of-sample bond return predictability. Bond return predictability is associated with periods of high (low) economic activity (uncertainty), which implies that violations of the expectations hypothesis are state dependent and linked to features of the business cycle. These state dependencies in predictability, established by introducing a new multivariate test for equal conditional predictive ability, can be used in real time to improve out-of-sample bond risk premia estimates and investors’ economic utility through a novel dynamic forecast combination scheme that uses predicted forecasting performance to identify the best set of methods to include in the combined forecast. Dynamically combined forecasts exhibit strong countercyclical behavior and peak during recessions.This paper was accepted by Lukas Schmid, finance.Funding: This work was supported by the Danish Council of Independent Research [Grants DFF 7024–00020B and DFF 9033–00003B] and the Danish Finance Institute.Supplemental Material: The data files and online appendices are available at https://doi.org/10.1287/mnsc.2023.4713 .

Financial Anomalies in Asset Allocation: Risk Mitigation with Cross-Sectional Equity Strategies

There is a myriad of financial anomalies in the cross-section of equity returns. They have been widely studied in the literature, which gives investors a large choice in terms of investment styles. In this article, the authors show a perhaps unappreciated quality of financial anomalies: They exhibit strong countercyclical behavior. Specifically, some anomalies (e.g., profitability and investment) perform particularly well when traditional portfolios (e.g., 60/40 or risk parity portfolios) exhibit prolonged periods of negative drawdowns and during National Bureau of Economic Research (NBER) recessions. With the exception of momentum strategies, the authors do not find evidence that financial anomalies are inflation hedging. Last, the authors examine whether financial anomalies lead to better portfolio performance. The results show that combining anomalies based on their style and then adding them to a traditional portfolio leads to higher Sharpe ratios overall, while also limiting portfolio losses during recessions.

THE IMPACT OF FISCAL SPACE ON INDONESIA’S FISCAL BEHAVIOR

This study investigates the impact of fiscal space on the probability that the government of Indonesia will be able to implement counter-cyclical fiscal behavior. We use ordinary least squares and probit methods to estimate the fiscal policy reaction function. This study confirms that increasing fiscal space can increase the probability of the government to execute its counter-cyclical behavior policy. A proposal to increase the space includes generating alternative sources of government revenues from taxes and non-taxes and redesigning subsidies toward selected targeting recipients to reduce the non-discretionary part of the government budget.

Corporate credit risk counter-cyclical interdependence: A systematic analysis of cross-border and cross-sector correlation dynamics

Sectoral corporate credit risk interlinkages constitute a highly topical issue for the systemic risk considerations of policymakers and market practitioners. We reveal the macroeconomic drivers of dynamic correlations between European and US sectoral Credit Default Swaps (CDS) markets. The CDS conditional equicorrelations are explained by common macro-financial and news proxies. Our results demonstrate the counter-cyclical behaviour of the time-varying sectoral CDS interdependence, that is elevated sectoral correlations are associated with higher economic policy and financial uncertainty, stronger infectious disease news impact on equity markets, tighter credit conditions, economic activity slowdown, and negative sentiment. We further focus on economic policy uncertainty (EPU) as a potent catalyst of the CDS markets integration process and conclude that EPU magnifies the macro effects across credit risk correlations. Moreover, crisis events play a crucial role in the time-varying impact of the correlation macro drivers. Both financial and health crises amplify the influence that the macro factors exert on the evolution of credit risk correlations, leading to credit risk contagion and threatening financial stability. Lastly, we show that understanding the credit contagion mechanisms has clear implications for operational research applications on risk and portfolio management.

Endogenous fluctuations and international business cycles

AbstractWe introduce equilibrium indeterminacy into a two‐country incomplete asset model with imperfect competition to analyze the role of self‐fulfilling expectations or beliefs in explaining international business cycles. We find that, when self‐fulfilling beliefs are correlated with technology shocks, the model can account for the countercyclical behaviour observed for the terms of trade and real net exports while simultaneously generating higher volatilities relative to output, as in the data. The choice of the labour‐supply elasticity is shown to be critical for generating a negative correlation between the real exchange rate and relative consumption, thereby resolving the Backus–Smith puzzle.

Is the shadow economy procyclical or countercyclical over the business cycle? International evidence

Using a panel of 123 countries observed from 1991 to 2017, this paper examines whether the shadow economy is procyclical or countercyclical over the business cycle. Specifically, we uniquely consider the influence of business cycle expansions (a rise in GDP per capita away from its long-term trend) and recessions (a decline in GDP per capita away from its long-term trend) on the underground sector, measured as the per capita growth rate of the shadow economy. Results show that the shadow sector exhibits countercyclical behavior over the business cycle, and this result is especially evident in non-OECD countries. Moreover, we find that the shadow economy is more responsive to business cycle expansions than recessions in the short run, while the response is symmetric in the long run. These findings are consistent with the underground sector functioning as an economic buffer to absorb the over or under capacity of the official sector.

Innovation in times of crisis: A systematic literature review

Today the world faces significant economic and financial crises, which have drawn firms into high levels of uncertainty and directly influences their innovation strategies. The literature on organizational decline reveals a lack of agreement about the effects of decline on innovation. This study aims to shed light on how economic crisis affects innovation and to provide a comprehensive picture of the innovation constraints and determinants with a focus on environmental factors. To add to the extant knowledge in the area of innovativeness in crisis, a systematic literature review using the Preferred Reporting Items for Systematic Reviews and Meta-Analyses was conducted. 70 conceptual and empirical research articles published in the period 2000–2021 from highly ranked journals according to the Association of Business Schools rating were reviewed. The article presents three identified patterns related to a firm’s innovation behaviour in crisis: а cyclical behaviour in which most of companies reduce their costs and become more unwilling to engage in innovation activities, a neutral behaviour with a view to keep the status quo, and a counter-cyclical behaviour when companies tend to boost their innovation activities. The three innovation behaviours are contingent on several factors that hamper innovation. Furthermore, the findings suggest that innovation positively affects the performance of firms in the context of crisis and this impact is contingent upon the level of environmental turbulence. This review contributes to the extant knowledge on the adaptation of firms to adverse environments. The study offers a nuanced understanding of the main innovation strategies to respond to the economic downturn at the firm and country level, highlights benefits of innovation in highly turbulent settings and gives a detailed description of factors that play an important role in counteracting the negative effect of crisis on firms’ investment in innovations.

The Behaviour of Intelligent Investors at Financial Markets: Insight from Slovenian Investors

Intelligent investors differ from speculative or non-professional investors in the fact that intelligent investors act countercyclically; that is, they act against the trend, or otherwise, they buy when prices have already fallen and sell when their rate of selected investment has already risen. An example of countercyclical behavior can also be explained by the thinking of professional investor Warren Buffett, who points out a simple investment rule: "Be scared when others are greedy, and be greedy when others are scared." Since crypto markets have recently emerged, there is a need for researching the best strategy for investments in their financial instruments. To get an insight into the behavior of Slovenian investors, in-depth interviews were conducted with a sample of financial experts. The article presents tips for the correct responses of intelligent investors in financial markets.
 This work is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.

The cyclical behavior of household and corporate credit in emerging economies

Standard consumption-investment theory predicts counter-cyclical (pro-cyclical) behavior of household (corporate) credit whereby households' consumption smoothing and firms' investment motives are aligned. Counter to the theoretical symbiosis consistent with U.S. data, we demonstrate not only in South Korea, but also in 19 emerging economies that the pro-cyclical behavior of household credit dominates that of corporate credit. Our analysis further reveals that dominant, pro-cyclical household credit accompanied by (collateral) assets and fueled by external debt generates counter-cyclical behavior in interest rates, amplifies credit market fluctuation, and hinders the growth of small- and medium-size businesses in the South Korean economy.

Predicting Bond Return Predictability

This paper provides empirical evidence on predictable time variations in out-of- sample bond return predictability. Bond return predictability is associated with periods of high (low) economic activity (uncertainty), which implies that violations of the expectations hypothesis are state-dependent and linked to features of the business cycle. These state-dependencies in predictability, established by introducing a new multivariate test for equal conditional predictive ability, can be used in real-time to improve out-of-sample bond risk premia estimates and investors’ economic utility through a novel dynamic forecast combination scheme that uses predicted forecasting performance to identify the best set of methods to include in the combined forecast. Dynamically combined forecasts exhibit strong countercyclical behavior and peak during recessions.

Taxation, credit frictions and the cyclical behavior of the labor wedge

Labor-income and consumption taxes are often referred to as the primary causes of the labor wedge and differences in hours worked across countries. While this can be potentially true in the long run, its premise for explaining the cyclical behavior of the labor wedge is questionable. Using US data over 1955–2019, this paper first studies whether taxation explains the cyclical behavior of the labor wedge. It is shown that the tax wedge, which combines both types of taxes, fails in accounting for the countercyclicality of the labor wedge. I then study other factors that may raise the labor wedge during recessions, such as credit frictions on the firms’ side and price markups, and find that credit frictions are the primary reasons for this behavior. The empirical findings are consistent with the model-based results; the model with credit frictions successfully generates a countercyclical behavior of the labor wedge, whereas the model without credit frictions does not.

Why Did Public Banks Lend More During the Global Financial Crisis?

During the Global Financial Crisis (GFC), state-owned or public banks lent relatively more than domestic private banks in many countries. However, data limitations have hindered a thorough assessment of what led public banks to better maintain lending during the GFC. Using a novel bank-level dataset covering 25 emerging market economies, we show that public banks lent relatively more during the GFC because they pursued an objective of helping to stabilize the economy, rather than because they had superior fundamentals or access to public or depositors’ funding. Nonetheless, their countercyclical behavior seems unique to the GFC rather than a regular characteristic of public banks before and after the GFC.

Nonparametric estimation of infinite order regression and its application to the risk-return tradeoff

This paper studies nonparametric estimation of the infinite order regression E(Ytk|Ft−1), k∈Z with stationary and weakly dependent data. We propose a Nadaraya–Watson type estimator that operates with an infinite number of conditioning variables. We propose a bandwidth sequence that shrinks the effects of long lags, so the influence of all conditioning information is modelled in a natural and flexible way, and the issues of omitted information bias and specification error are effectively handled. We establish the asymptotic properties of the estimator under a wide range of static and dynamic regressions frameworks, thereby allowing various kinds of conditioning variables to be used. We establish pointwise/uniform consistency and CLTs. We show that the convergence rates are at best logarithmic, and depend on the smoothness of the regression, the distribution of the marginal regressors and their dependence structure in a non-trivial way via the Lambert W function. We apply our methodology to examine the intertemporal risk-return relation for the aggregate stock market, and some new empirical evidence is reported. For the S&P 500 daily data from 1950 to 2017 using our estimator we report an overall positive risk-return relation. We also find evidence of strong time variation and counter-cyclical behaviour in risk aversion. These conclusions are possibly attributable to the allowance of further flexibility and the inclusion of otherwise neglected information in our method.