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Credit risk and disaster risk

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  • Francois Gourio

Abstract

Credit spreads are large, volatile and countercyclical, and recent empirical work suggests that risk premia, not expected credit losses, are responsible for these features. Building on the idea that corporate debt, while safe in ordinary recessions, is exposed to economic depressions, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, exogenously time-varying risk of economic disaster. The model replicates the level, volatility and cyclicality of credit spreads, and variation in the corporate bond risk premium amplifies macroeconomic fluctuations in investment, employment and GDP.

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Paper provided by Federal Reserve Bank of Chicago in its series Working Paper Series with number WP-2012-07.

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Date of creation: 2012
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Handle: RePEc:fip:fedhwp:wp-2012-07

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Keywords: Risk - Mathematical models ; Credit ; Debt;

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Cited by:
  1. Serena Ng & Jonathan H. Wright, 2013. "Facts and Challenges from the Great Recession for Forecasting and Macroeconomic Modeling," Journal of Economic Literature, American Economic Association, vol. 51(4), pages 1120-54, December.
  2. Eric T. Swanson, 2013. "Implications of labor market frictions for risk aversion and risk premia," Working Paper Series 2013-30, Federal Reserve Bank of San Francisco.
  3. Robert J. Barro & José F. Ursua, 2011. "Rare Macroeconomic Disasters," NBER Working Papers 17328, National Bureau of Economic Research, Inc.
  4. Francesco Bianchi & Cosmin L. Ilut & Martin Schneider, 2014. "Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle," NBER Working Papers 20081, National Bureau of Economic Research, Inc.
  5. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Rare Disasters: Implications for Consumptions and Asset Prices," CEU Working Papers 2014_2, Department of Economics, Central European University.
  6. Jianjun Miao & PENGFEI WANG, 2010. "Credit Risk and Business Cycles," Boston University - Department of Economics - Working Papers Series WP2010-033, Boston University - Department of Economics.
  7. Max Gillman & Michal Kejak & Michal Pakos, 2014. "Learning about Disaster Risk: Joint Implications for Consumption and Asset Prices," CERGE-EI Working Papers wp507, The Center for Economic Research and Graduate Education - Economic Institute, Prague.
  8. Elías Albagli & Christian Hellwig & Aleh Tsyvinski, 2014. "Dynamic Dispersed Information and the Credit Spread Puzzle," Working Papers Central Bank of Chile 720, Central Bank of Chile.
  9. Sylvain Leduc & Zheng Liu, 2012. "Uncertainty shocks are aggregate demand shocks," Working Paper Series 2012-10, Federal Reserve Bank of San Francisco.
  10. Sylvain, Serginio, 2014. "Does Human Capital Risk Explain The Value Premium Puzzle?," MPRA Paper 54551, University Library of Munich, Germany.
  11. Peter Christoffersen & Du Du & Redouane Elkamhi, 2013. "Rare Disasters and Credit Market Puzzles," CREATES Research Papers 2013-45, School of Economics and Management, University of Aarhus.
  12. Eric T. Swanson, 2012. "Risk aversion, risk premia, and the labor margin with generalized recursive preferences," Working Paper Series 2012-17, Federal Reserve Bank of San Francisco.

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