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

63 Pages Posted: 21 Mar 2012 Last revised: 15 Nov 2019

See all articles by Hui Chen

Hui Chen

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

Yu Xu

The University of Hong Kong - Faculty of Business and Economics

Jun Yang

Bank of Canada

Multiple version iconThere are 2 versions of this paper

Date Written: November 14, 2019

Abstract

We document several facts on the link between firms' systematic risk exposure and debt maturity: (1) debt maturity is pro-cyclical; (2) firms with higher systematic risk exposure tend to have longer debt maturity; and (3) shorter maturity can significantly amplify the sensitivity of credit spreads to aggregate shocks. We build a dynamic capital structure model to explain these findings. Departing from the standard approach for modeling finite-maturity debt, we assume that debt maturity is lumpy and that firms can optimally readjust their capital structure when existing debt matures. These features make leverage and maturity choices highly interdependent. Optimal debt maturity depends on 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. The model generates rich dynamics of leverage and debt maturity in the cross section and over the business cycle, and it can account for our empirical findings.

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

JEL Classification: E44, G12, G32, G33

Suggested Citation

Chen, Hui and Xu, Yu and Yang, Jun, Systematic Risk, Debt Maturity, and the Term Structure of Credit Spreads (November 14, 2019). Available at SSRN: https://ssrn.com/abstract=2024329 or http://dx.doi.org/10.2139/ssrn.2024329

Hui Chen (Contact Author)

Massachusetts Institute of Technology ( email )

50 Memorial Drive
Cambridge, MA 02142
United States
617-324-3896 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yu Xu

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Jun Yang

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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