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Capital Structure, Credit Risk, and Macroeconomic Conditions

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  • Dirk Hackbarth

    ()
    (Finance Department, Kelley School of Business, University of Indiana)

  • Jianjun Miao

    ()
    (Department of Economics, Boston University)

  • Erwan Morellec

    ()
    (HEC, University of Lausanne and FAME)

Abstract

This paper develops a framework for analyzing the impact of macroeceomic conditions on credit risk and dynamic capital structure choice. We begin by observing that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase. We then demonstrate that this simple observation has a wide range of implications for corporations. Notably, we show that our model can replicate observed debt levels and the countercyclicality of leverage ratios. We also demonstrate that it can reproduce the observed term structure of credit spreads and generate strictly positive credit spreads for very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity. A number of new predictions follow.

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Bibliographic Info

Paper provided by International Center for Financial Asset Management and Engineering in its series FAME Research Paper Series with number rp125.

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Date of creation: May 2004
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Handle: RePEc:fam:rpseri:rp125

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Keywords: Dynamic capital structure; Credit spreads; Macroeconomic conditions;

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References

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