Cyclical Dispersion in Expected Defaults

51 Pages Posted: 21 Aug 2017 Last revised: 9 Apr 2021

See all articles by Joao F. Gomes

Joao F. Gomes

The Wharton School

Marco Grotteria

London Business School

Jessica A. Wachter

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

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Date Written: August 2017

Abstract

A growing literature shows that credit indicators forecast aggregate real outcomes. While researchers have 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.

Suggested Citation

Gomes, João F. and Grotteria, Marco and Wachter, Jessica A., Cyclical Dispersion in Expected Defaults (August 2017). NBER Working Paper No. w23704, Available at SSRN: https://ssrn.com/abstract=3023102

João F. Gomes (Contact Author)

The Wharton School ( email )

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Marco Grotteria

London Business School ( email )

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HOME PAGE: http://https://sites.google.com/site/marcogrotteria/

Jessica A. Wachter

University of Pennsylvania - Finance Department ( email )

The Wharton School
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Philadelphia, PA 19104
United States
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215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

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