Incomplete Information, Debt Issuance, and the Term Structure of Credit Spreads

65 Pages Posted: 25 Sep 2019 Last revised: 28 Sep 2020

See all articles by Luca Benzoni

Luca Benzoni

Federal Reserve Bank of Chicago - Research Department

Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business

Robert S. Goldstein

University of Minnesota - Twin Cities - Carlson School of Management; National Bureau of Economic Research (NBER)

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Date Written: September 21, 2020

Abstract

We propose a tractable bond pricing model in which managers have an informational advantage over creditors. We show that, regardless of how poor their private signal is, managers of firms that can access the credit market will avoid default by issuing new debt to service existing debt. Therefore, only bonds of firms that have exhausted their ability to borrow are subject to jump-to-default risk due to incomplete information and, in turn, command a jump-to-default risk premium. We document that our model captures many salient features of the corporate bond market.

Keywords: Bond pricing; Credit spreads; Jumps to Default

JEL Classification: G12, G32, G33

Suggested Citation

Benzoni, Luca and Garlappi, Lorenzo and Goldstein, Robert S., Incomplete Information, Debt Issuance, and the Term Structure of Credit Spreads (September 21, 2020). Available at SSRN: https://ssrn.com/abstract=3454816 or http://dx.doi.org/10.2139/ssrn.3454816

Luca Benzoni (Contact Author)

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Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business ( email )

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Robert S. Goldstein

University of Minnesota - Twin Cities - Carlson School of Management ( email )

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National Bureau of Economic Research (NBER)

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