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Credit Risk and Business Cycles

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  • Jianjun Miao

    ()
    (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University)

  • PENGFEI WANG

    ()
    (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)

Abstract

We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk ampli¯es aggregate tech- nology shocks. The debt-capital ratio is a new state variable and its endogenous movements provide a propagation mechanism. The model can match the persistence and volatility of output growth as well as the mean equity premium and the mean risk-free rate as in the data. The model implied credit spreads are countercyclical and forecast future economic activities because they a®ect ¯rm investment through Tobin's Q. They also forecast future stock returns through changes in the market price of risk. Finally, we show that ¯nancial shocks to the credit markets are transmitted to the real economy through Tobin's Q.

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Bibliographic Info

Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Working Papers Series with number WP2010-033.

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Length: 48 pages
Date of creation: Jan 2010
Date of revision:
Handle: RePEc:bos:wpaper:wp2010-032

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Related research

Keywords: credit risk; credit spread; dynamic capital structure; equity premium; business cycles; investment; q-theory;

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References

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  1. Francois Gourio, 2011. "Credit Risk and Disaster Risk," NBER Working Papers 17026, National Bureau of Economic Research, Inc.
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  31. Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Levered Equity Risk Premium and Credit Spreads: A Unified Framework," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 645-703, February.
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Citations

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Cited by:
  1. Vincenzo Quadrini, 2011. "Financial frictions in macroeconomic fluctations," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 209-254.
  2. Francois Gourio, 2011. "Credit Risk and Disaster Risk," NBER Working Papers 17026, National Bureau of Economic Research, Inc.
  3. repec:fip:fedreq:y:2011:i:3q:p:209-254:n:vol.97no.3 is not listed on IDEAS
  4. Jianjun Miao & PENGFEI WANG, 2011. "Bubbles and Credit Constraints," Boston University - Department of Economics - Working Papers Series WP2011-031, Boston University - Department of Economics.
  5. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages S17-S34.
  6. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series 1463, European Central Bank.
  7. Douglas Gale & Piero Gottardi, 2013. "Capital Structure and Investment Dynamics with Fire Sales," Economics Working Papers ECO2013/09, European University Institute.

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