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Growth Options, Macroeconomic Conditions and the Cross-Section of Credit RiskMarc ArnoldSwiss Finance Institute Alexander F. WagnerUniversity of Zurich - Department of Banking and Finance; Harvard University; Swiss Finance Institute; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI) Ramona WestermannSwiss Finance Institute January 9, 2012 Swiss Finance Institute Research Paper No. 10-19 Journal of Financial Economics (JFE), Forthcoming Abstract: This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared to firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross-section of all these features.
Number of Pages in PDF File: 91 Keywords: Asset composition, capital structure, credit spread puzzle, equity premium, growth options, macroeconomic risk, value premium JEL Classification: G32 Accepted Paper SeriesDate posted: March 17, 2010 ; Last revised: April 13, 2012Suggested CitationContact Information
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