Credit Risk and Business Cycles

48 Pages Posted: 9 Mar 2011

See all articles by Pengfei Wang

Pengfei Wang

HKUST, Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Jianjun Miao

Boston University - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 8, 2010

Abstract

We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk amplifies aggregate technology shocks. The debt-capital ratio is a new state variable and its endogenous movements provide a propagation mechanism. The model can match the persistence and volatility of output growth as well as the mean equity premium and the mean risk-free rate as in the data. The model implied credit spreads are countercyclical and forecast future economic activities because they affect firm investment through Tobin's Q. They also forecast future stock returns through changes in the market price of risk. Finally, we show that financial shocks to the credit markets are transmitted to the real economy through Tobin's Q.

Keywords: Credit Risk, Credit Spread, Dynamic Capital Structure, Equity Premium, Business Cycles

JEL Classification: E22, E32, G12, G32, G33

Suggested Citation

Wang, Pengfei and Miao, Jianjun, Credit Risk and Business Cycles (September 8, 2010). Available at SSRN: https://ssrn.com/abstract=1780254 or http://dx.doi.org/10.2139/ssrn.1780254

Pengfei Wang (Contact Author)

HKUST, Department of Economics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

Jianjun Miao

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-6675 (Phone)

HOME PAGE: http://people.bu.edu/miaoj

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