Macroeconomic conditions and the puzzles of credit spreads and capital structure, Working paper (2007)
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@MISC{Chen07macroeconomicconditions,
author = {Hui Chen and Frederico Belo and Sergei Davydenko and Darrel Duffie and Gene Fama and Vito Gala and Raife Giovinazzo and Dirk Hackbarth and Milt Harris and John Heaton and Andrew Hertzberg and Pete Kyle and Francis Longstaff and Jianjun Miao and Stewart My},
title = {Macroeconomic conditions and the puzzles of credit spreads and capital structure, Working paper},
year = {2007}
}
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Abstract
Investors demand high risk premia for defaultable claims, because (i) defaults tend to con-centrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with business-cycle variations in expected growth rates and volatility, which endogenously generate countercyclical comovements in risk prices, default probabilities, and default losses. Credit risk premia in the calibrated model not only can quantitatively account for the high corporate bond yield spreads and low leverage ratios in the data, but have rich implications for firms ’ financing decisions. Risks associated with macroeconomic conditions are crucial for understanding asset prices. Naturally, they should also have important implications for corporate decisions. By introducing macroeconomic conditions into firms ’ financing decisions, this paper provides a risk-based expla-
