Persistent Crises and Levered Asset Prices

59 Pages Posted: 9 Jan 2021

See all articles by Lars-Alexander Kuehn

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business

David Schreindorfer

Arizona State University

Florian Schulz

University of Washington

Date Written: November 19, 2020

Abstract

We rationalize the joint behavior of aggregate consumption, asset prices, and financial leverage by incorporating persistent macroeconomic crises into a structural credit risk model. As in the data, longer-lasting crises are associated with more severe macroeconomic contractions and larger increases in leverage ratios, credit risk, and return volatility. Leverage provides a strong propagation mechanism for fundamental shocks because it continues to rise while crises endure. The model replicates the firm-level implied volatility curve and its cross-sectional relation with observable proxies of default risk. Lastly, a structural estimation reveals that common idiosyncratic risk is an important driver of credit spreads.

Keywords: Long-lasting consumption crises, Epstein-Zin preferences, SMM, credit risk, option pricing

JEL Classification: G01,G12, G13,G32

Suggested Citation

Kuehn, Lars-Alexander and Schreindorfer, David and Schulz, Florian, Persistent Crises and Levered Asset Prices (November 19, 2020). Available at SSRN: https://ssrn.com/abstract=3733255 or http://dx.doi.org/10.2139/ssrn.3733255

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

David Schreindorfer (Contact Author)

Arizona State University ( email )

Farmer Building 440G PO Box 872011
Tempe, AZ 85287
United States
4809656212 (Phone)

HOME PAGE: http://www.davidschreindorfer.com

Florian Schulz

University of Washington

Box 353226
Seattle, WA 98195
United States

HOME PAGE: http://sites.google.com/site/schulzflor/home/personal

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