Academic journal article Journal of Money, Credit & Banking

International Lending by U.S. Banks

Academic journal article Journal of Money, Credit & Banking

International Lending by U.S. Banks

Article excerpt

A COMMON PHENOMENON is that the decisions of some individuals are influenced by what others have already done. From a Bayesian perspective, it is not surprising that the actions of those who go first, the leaders, are often mimicked by those who follow as the leaders' actions can provide information that influences the choices made by later decision makers. Two questions arise in such sequential decision-making servings: Can we determine ex ante who will be the leaders and who will be the followers? Can we identify observable factors that determine the extent to which the followers' actions mimic the leaders' actions?

The purpose of this paper is to answer the above two questions in a model that highlights how heterogeneity across agents can result in an endogenous determination of who leads and who follows. Specifically, we examine in the context of an investment decision how wealth affects the choice of an investor to either purchase current information, or wait and later determine the level of investment based on information inferred from the decisions of others. Because agents with low wealth gain less from the purchase of current information and because the quality of delayed information inferred from the actions of those who do purchase such information increases with the number of informed investors, it is those with low wealth who may find it advantageous to wait and invest later. Thus we obtain an endogenous separation of investors into leaders and followers based on their level of wealth. Further, we show that the extent of such separation is related to the persistence in states of the world across time. In particular, if states are not correlated across periods, prior investment behavior provides no valuable information about the state in the current period.

Some of the implications of the model are tested using data on international lending by U.S. banks for the 1982-1994 period.(1) The empirical results support the main predictions of the model. First, we find that small banks follow the lending behavior of large banks with regard to which countries to lend to. The theory developed also suggests that the extent of such behavior will depend on the persistence in states of the world. We develop a measure of persistence in terms of economic conditions and find that, as predicted, small banks follow large banks to a greater extent in countries where there is more persistence in economic conditions.

The analysis in this paper builds upon the work of Jain and Gupta (1987), who provide some evidence of "herd behavior" in international lending. Our analysis differs from theirs in two respects. First, with regard to the theoretical analysis, we construct a model that highlights the important role of persistence in determining the extent to which small banks follow large. In doing so, we incorporate some of the features of what has been termed the "herd behavior" phenomenon. In herd behavior models along the lines of Banerjee (1992), the choice by some to follow is "socially excessive" in that such choices hide useful information from others.(2) In our model, the choice by some to follow means not purchasing information that others would find useful. Second, we extend the empirical analysis to a broader time period and a larger number of countries, and we provide new tests of the role of persistence in explaining the patterns of international lending.

The next section presents a model of an investor facing incomplete information. We then discuss the empirical implications with respect to international lending. In the final two sections of the paper, we discuss the data, present the empirical tests of the theory, and offer concluding remarks.

1. A SIMPLE MODEL

We begin our analysis with a simple portfolio problem for an agent i with wealth to invest [W.sub.i]. There are two types of investments: a risky asset and a risk-free asset. The risky asset pays one of two possible returns: [R. …

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