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How Much Leverage is too Much, or Does Corporate Risk Determine the Severity of a Recession?

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  • Iryna V. Ivaschenko
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    Abstract

    Economic theory suggests that vulnerable financial conditions of the corporate sector can trigger or worsen an economy-wide recession. This paper proposes a measure of corporate vulnerability, the Corporate Vulnerability Index (CVI) and analyses whether it can explain the probability and severity of recessions. The CVI is constructed as the default probability for the entire corporate sector, using the model of corporate debt by Anderson, Sundaresan, and Tychon (1996). The CVI is shown to be a significant predictor of the probability of a recession 4 to 6 quarters ahead, even controlling for other leading indicators. An increase in the CVI is also associated with an increase in the probability of a more severe and lengthy recession 3 to 6 quarters ahead.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/3.

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    Length: 32
    Date of creation: 01 Jan 2003
    Date of revision:
    Handle: RePEc:imf:imfwpa:03/3

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    Related research

    Keywords: Exchange risk; Economic recession; Economic forecasting; recession; bond; recessions; corporate bond; corporate sector; bonds; bond yields; bond yield; corporate bonds; treasury bonds; bond index; stock returns; perpetual bond; risk-free interest rate; severe recession; financial economics; corporate bond index; stock index; bondholders; stock prices; aggregate bond index; treasury bond; bond spreads; financial distress; debt structure; stock market; cash flows; present value; cash flow; interest rate risk; bond valuation; stock price; callable bonds; government bond; equity market; discount rate; economic recessions; financial crisis; discount bond; government bond yields; bond issuers; financial services; municipal bond; stock market volatility; financial fragility; perpetual bonds; financial contracts; bond rates; financial markets; severe recessions; financial assets; future cash flows; bond market; corporate bond issuers; future value; financial market;

    References

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    Cited by:
    1. De Bandt, O. & Bruneau, C. & El Amri, W., 2008. "Stress Testing and Corporate Finance," Working papers 203, Banque de France.

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