Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

Journal of Finance, Forthcoming

58 Pages Posted: 30 Sep 2009

See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology

Multiple version iconThere are 2 versions of this paper

Date Written: September 25, 2009

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 Classification: E44, G12, G13, G32, G33

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: https://ssrn.com/abstract=1480409

Hui Chen (Contact Author)

Massachusetts Institute of Technology ( email )

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United States
+1 (617) 324-3896 (Phone)

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