Debt Dynamics and Credit Risk

68 Pages Posted: 27 Jun 2019

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 a theoretical and empirical examination of these dynamics. Empirically, the future level of debt in US industrial firms is negatively related to current leverage. Furthermore, when a firm experiences a negative shock to it's equity, debt increases in the short run but declines in the long run. We incorporate these dynamics of debt into a structural model of credit risk and compare the term structure of default rates and credit spreads with those in existing models. The model improves the ability to capture the level of credit spreads particularly at short maturities.

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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