Systematic Risk, Debt Maturity, and the Term Structure of Credit Spreads

Abstract

We document several facts about corporate debt maturity: (1) debt maturity is pro-cyclical; (2) higher-beta firms tend to have longer debt maturity; (3) shorter maturity amplifies the sensitivity of credit spreads to aggregate shocks. We build a dynamic capital structure model that explains these facts. In the model, leverage and maturity choices are highly interdependent, which reflects the tradeoffs of liquidity discounts of long-term debt, repayment risks of short-term debt, and the benefit of short-term debt as a commitment device for timely leverage adjustments. Additionally, the model quantifies the effects of maturity dynamics on the term structure of credit spreads.

Keywords: credit risk, term structure, business cycle, maturity dynamics, liquidity

JEL Classification: E32, G12, G32, G33