The Aggregate Dynamics of Capital Structure and Macroeconomic Risk
Harjoat Singh Bhamra
University of British Columbia - Sauder School of Business
Carnegie Mellon University - David A. Tepper School of Business
Ilya A. Strebulaev
Stanford University - Graduate School of Business; National Bureau of Economic Research
September 8, 2008
We study the impact of time-varying macroeconomic conditions on optimal dynamic capital structure and the aggregate dynamics of firms in a cross-section. Our structural-equilibrium framework embeds a contingent-claim corporate financing model within a standard consumption-based asset-pricing model. This enables us to investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies as well as study the impact of preferences on capital structure. We find that capital structure is pro-cyclical at refinancing dates when firms relever, but counter-cyclical in aggregate dynamics, consistent with empirical evidence. Financially constrained firms follow more pro-cyclical policies. Capital structure is path-dependent. Leverage accounts for most of the macroeconomic risk relevant for predicting defaults. The paper also develops a number of novel empirically testable conjectures on capital structure in a dynamic economy.
Number of Pages in PDF File: 58
Keywords: Dynamic capital structure, leverage, aggregate dynamics, cross-sectional behavior, default probability, financial constraints, macroeconomic risk, risk aversion, elasticity of intertemporal substitution
JEL Classification: E44, G12, G32, G33working papers series
Date posted: September 10, 2008 ; Last revised: November 6, 2009
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