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Growth Options, Macroeconomic Conditions and the Cross-Section of Credit Risk

Posted: 17 Mar 2010 Last revised: 23 Jan 2016

Marc Arnold

University of St. Gallen - School of Finance

Alexander F. Wagner

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swiss Finance Institute

Ramona Westermann

Copenhagen Business School

Date Written: January 9, 2012

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.

Keywords: Asset composition, capital structure, credit spread puzzle, equity premium, growth options, macroeconomic risk, value premium

JEL Classification: G32

Suggested Citation

Arnold, Marc and Wagner, Alexander F. and Westermann, Ramona, Growth Options, Macroeconomic Conditions and the Cross-Section of Credit Risk (January 9, 2012). Journal of Financial Economics (JFE), 2013, vVol. 107, pp. 350-385; Swiss Finance Institute Research Paper No. 10-19. Available at SSRN: https://ssrn.com/abstract=1570353 or http://dx.doi.org/10.2139/ssrn.1570353

Marc Arnold

University of St. Gallen - School of Finance ( email )

Unterer Graben 21
St.Gallen, CH-9000
Switzerland

Alexander F. Wagner (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland
+41 44 634 3963 (Phone)

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Swiss Finance Institute ( email )

Switzerland

HOME PAGE: http://www.alex-wagner.com

Ramona Westermann

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

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