The Aggregate Dynamics of Capital Structure and Macroeconomic Risk

58 Pages Posted: 10 Sep 2008 Last revised: 6 Nov 2009

Harjoat Singh Bhamra

Imperial College Business School

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business

Ilya A. Strebulaev

Stanford University - Graduate School of Business; National Bureau of Economic Research

Date Written: September 8, 2008

Abstract

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.

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, G33

Suggested Citation

Bhamra, Harjoat Singh and Kuehn, Lars-Alexander and Strebulaev, Ilya A., The Aggregate Dynamics of Capital Structure and Macroeconomic Risk (September 8, 2008). Available at SSRN: https://ssrn.com/abstract=1265870 or http://dx.doi.org/10.2139/ssrn.1265870

Harjoat Singh Bhamra

Imperial College Business School ( email )

Tanaka Building
Exhibition Rd
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www.harjoatbhamra.com

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Ilya A. Strebulaev (Contact Author)

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

HOME PAGE: http://faculty-gsb.stanford.edu/strebulaev/

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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