Vanishing Contagion Spreads

50 Pages Posted: 15 Dec 2017 Last revised: 9 Mar 2019

See all articles by Diogo Duarte

Diogo Duarte

Florida International University (FIU) - Department of Finance

Rodolfo Prieto

INSEAD

Marcel Rindisbacher

Questrom School of Business, Boston University; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Yuri Saporito

Getulio Vargas Foundation (FGV) - EMAp - School of Applied Mathematics

Date Written: March 7, 2019

Abstract

We study default in a multi-firm equilibrium setting with incomplete information. Defaults are modeled to be consistent with the firm's balance sheet and aggregation over firms. Market prices and quantities of risk are derived in closed form. If the number of firms increases, the market prices of risk converge to a well-defined limit while the endogenous volatility and jump size of debt and equity generated by other firms' shocks vanish so that credit spreads depend asymptotically only on the firms' own cash flow risk. This novel contagion result calls into question recent results based on production economies, where quantities of risk are specified exogenously, that attribute credit spreads mostly to contagion.

Keywords: Credit Risk, Credit Spreads, Contagion, Exchange Economy, Equilibrium, Idiosyncratic shocks, Risk Premia Representation

JEL Classification: G12, G13, G30

Suggested Citation

Duarte, Diogo and Prieto, Rodolfo and Rindisbacher, Marcel and Saporito, Yuri, Vanishing Contagion Spreads (March 7, 2019). Available at SSRN: https://ssrn.com/abstract=3086679 or http://dx.doi.org/10.2139/ssrn.3086679

Diogo Duarte (Contact Author)

Florida International University (FIU) - Department of Finance ( email )

University Park
11200 SW 8th Street
Miami, FL 33199
United States

Rodolfo Prieto

INSEAD ( email )

Boulevard de Constance
77305 Fontainebleau Cedex
France

Marcel Rindisbacher

Questrom School of Business, Boston University ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States
617 353 4152 (Phone)
617 353 999 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

Yuri Saporito

Getulio Vargas Foundation (FGV) - EMAp - School of Applied Mathematics ( email )

Praia de Botafogo
Rio de Janeiro, 22250-900
Brazil

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