Economic Uncertainty, Disagreement, and Credit Markets

Abstract:     
We study how the equilibrium risk-sharing of agents with heterogenous perceptions of aggregate consumption growth affects bond and stock returns. While credit spreads and their volatilities increase with the degree of heterogeneity, the decreasing risk premium on moderately levered equity can produce a violation of basic capital structure no-arbitrage relations. Using bottom-up proxies of aggregate belief dispersion, we give empirical support to the model predictions and show that risk premia on corporate bond and stock returns are systematically explained by their exposures to aggregate disagreement shocks.

Number of Pages in PDF File: 38

Keywords: Credit Risk, Credit Spreads, Heterogeneous Beliefs, Uncertainty

JEL Classification: D80, G12, G13

working papers series