Investment-Based Corporate Bond Pricing

57 Pages Posted: 20 Sep 2011 Last revised: 10 Jun 2014

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business

Lukas Schmid

Duke University - The Fuqua School of Business

Date Written: June 6, 2014

Abstract

A standard assumption of structural models of default is that firms' assets evolve exogenously. In this paper, we examine the importance of accounting for investment options in models of credit risk. In the presence of financing and investment frictions, fi rm-level variables that proxy for asset composition are significant determinants of credit spreads beyond leverage and asset volatility, because they capture the systematic risk of firms' assets. Cross-sectional studies of credit spreads that fail to control for the interdependence of leverage and investment decisions are unlikely to be very informative. Such frictions also give rise to a realistic term structure of credit spreads in a production economy.

Keywords: Real investment, dynamic capital structure, default risk, credit spreads, recursive preferences, macroeconomic risk

JEL Classification: E22, E44, G12, G32, G33

Suggested Citation

Kuehn, Lars-Alexander and Schmid, Lukas, Investment-Based Corporate Bond Pricing (June 6, 2014). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1929830 or http://dx.doi.org/10.2139/ssrn.1929830

Lars-Alexander Kuehn (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Lukas Schmid

Duke University - The Fuqua School of Business ( email )

Durham, NC 27708-0120
United States

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