64 Pages Posted: 1 Jun 2018 Last revised: 15 Sep 2019
Date Written: September 12, 2019
The default of certain entities can have disastrous effects on the economy. This paper présents a framework aimed at analyzing the asset pricing and macro implications of “systemic defaults”. This framework is flexible and tractable enough to simultaneously replicate the price fluctuations of various far-out-of-the-money (disaster-exposed) credit and equity derivatives. According to our estimation results, market data imply that the default of a systemic entity is expected to be followed by a 3% decrease in consumption. The recessionary influence of systemic defaults implies that financial instruments whose payoffs are exposed to such credit events carry substantial risk premiums.
Keywords: Disaster Risk, Systemic Entities, Default Dependencies, Credit Derivatives, Equilibrium Model
JEL Classification: E43, E44, E47, G01, G12
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