Data and Code for: Real Credit Cycles

We embed diagnostic expectations in a workhorse neoclassical model with heterogeneous firms and risky debt. A realistic degree of overreaction estimated from US firms’
earnings forecasts generates realistic credit cycles. Good times produce economic and
financial fragility, predicting future disappointment of expectations, low bond returns,
and investment declines. To generate the size of spread increases observed during
2007-9, the model requires only moderate negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.