Cyclical Dispersion in Expected Defaults
61 Pages Posted: 10 Apr 2017 Last revised: 17 Mar 2018
Date Written: March 13, 2018
A growing literature shows that credit indicators forecast aggregate real outcomes. While the literature has proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless, model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.
Keywords: Expected Default, Bond Issuance, Business Cycles, Disaster Risk
JEL Classification: G12, G32, E32
Suggested Citation: Suggested Citation