Growth Options, Macroeconomic Conditions and the Cross-Section of Credit Risk
Posted: 17 Mar 2010 Last revised: 23 Jan 2016
Date Written: January 9, 2012
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
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