Price Rigidities and Credit Risk

80 Pages Posted: 25 May 2021 Last revised: 21 Jun 2023

See all articles by Patrick Augustin

Patrick Augustin

McGill University; McGill University, Desautels Faculty of Management

Linxiao Francis Cong

McGill University - Desautels Faculty of Management

Alexandre Corhay

University of Toronto - Rotman School of Management

Michael Weber

University of Chicago - Finance; National Bureau of Economic Research (NBER)

Date Written: June 20, 2023

Abstract

We develop a capital structure model in which firms have a differential flexibility in adjusting
output prices to shocks. Inflexible-price firms have lower profits and higher cash-flow
volatility, leading in equilibrium to lower financial leverage, shorter debt duration, higher
cost of debt, more stringent debt covenants, and higher precautionary cash holdings. Shocks
to cash-flow volatility increase the cost of debt more for inflexible-price firms. We confirm
these predictions empirically and document that inflexible-price firms experience a significantly
larger increase in credit spreads in response to monetary policy shocks and to the
2008 Lehman Brothers bankruptcy, especially when they face higher pre-shock rollover risk.

Keywords: sticky prices, monetary policy, credit risk, nominal rigidities

JEL Classification: E12, E44, E52, G12, G28, G32, G33

Suggested Citation

Augustin, Patrick and Augustin, Patrick and Cong, Linxiao and Corhay, Alexandre and Weber, Michael, Price Rigidities and Credit Risk (June 20, 2023). Chicago Booth Research Paper No. 21-14, Fama-Miller Working Paper, Available at SSRN: https://ssrn.com/abstract=3852082 or http://dx.doi.org/10.2139/ssrn.3852082

Patrick Augustin

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://https://patrickaugustin.ca/

McGill University, Desautels Faculty of Management ( email )

1001 Sherbrooke Street West
Quebec
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://www.patrickaugustin.se

Linxiao Cong

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Alexandre Corhay

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
4169780512 (Phone)

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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