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Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

Hui Chen
Massachusetts Institute of Technology



Journal of Finance, Forthcoming

Abstract:     
I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to the macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the "credit spread puzzle" and "under-leverage puzzle" in a unified framework. The model generates interesting dynamics for financing and defaults, including "credit contagion" and market timing of debt issuance. It also provides a novel procedure to estimate state-dependent default losses.

Keywords: capital structure, credit spread, default risk, business cycle, default losses

JEL Classifications: E44, G12, G13, G32, G33

Accepted Paper Series

Date posted: September 30, 2009 ; Last revised: September 30, 2009

Suggested Citation

Chen, Hui, Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure (September 25, 2009). Journal of Finance, Forthcoming. Available at SSRN: http://ssrn.com/abstract=1480409


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Contact Information

Hui Chen (Contact Author)
Massachusetts Institute of Technology ( email )
50 Memorial Drive
Cambridge, MA 02142
United States
617-324-3896 (Phone)
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