Debt Dynamics and Credit Risk
68 Pages Posted: 27 Jun 2019
Date Written: June 25, 2019
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
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