Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

59 Pages Posted: 7 Jul 2010 Last revised: 20 Aug 2010

See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

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Date Written: July 2010

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.

Suggested Citation

Chen, Hui, Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure (July 2010). NBER Working Paper No. w16151, Available at SSRN: https://ssrn.com/abstract=1635674

Hui Chen (Contact Author)

Massachusetts Institute of Technology ( email )

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National Bureau of Economic Research (NBER) ( email )

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