Debt Dynamics and Credit Risk

68 Pages Posted: 27 Jun 2019 Last revised: 23 Nov 2020

See all articles by Peter Feldhütter

Peter Feldhütter

Copenhagen Business School

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting

Date Written: June 25, 2019

Abstract

The dynamics of debt are crucial in structural models of credit risk and this paper provides new empirical evidence on these dynamics. For US industrial firms, we find that the future level of debt is negatively related to current leverage. Furthermore, when a firm experiences a negative shock to its equity, debt increases in the short run but declines in the long run, relative to a positive-shock firm. We incorporate these features into a new structural model of credit risk and compare the model's ability to match the cross-section of US credit spreads with that of existing models. The model provides more accurate predictions of credit spreads, particularly for short-maturity investment grade debt.

Keywords: Structural Models, Debt Levels, Default Rates, Default Boundary, Credit Risk

JEL Classification: C23, G12

Suggested Citation

Feldhütter, Peter and Schaefer, Stephen M., Debt Dynamics and Credit Risk (June 25, 2019). Available at SSRN: https://ssrn.com/abstract=3410079 or http://dx.doi.org/10.2139/ssrn.3410079

Peter Feldhütter (Contact Author)

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 171 706 6887 (Phone)
+44 171 724 3317 (Fax)

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