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Systematic Risk, Debt Maturity, and the Term Structure of Credit Spreads

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  • Hui Chen
  • Yu Xu
  • Jun Yang
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Abstract

We build a dynamic capital structure model to study the link between firms' systematic risk exposures and their time-varying debt maturity choices, as well as its implications for the term structure of credit spreads. Compared to short-term debt, long-term debt helps reduce rollover risks, but its illiquidity raises the costs of financing. With both default risk and liquidity costs changing over the business cycle, our calibrated model implies that debt maturity is pro-cyclical, firms with high systematic risk favor longer debt maturity, and that these firms will have more stable maturity structures over the cycle. Moreover, pro-cyclical maturity variation can significantly amplify the impact of aggregate shocks on the term structure of credit spreads, especially for firms with high beta, high leverage, or a lumpy maturity structure. We provide empirical evidence for the model predictions on both debt maturity and credit spreads.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18367.

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Date of creation: Sep 2012
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Handle: RePEc:nbr:nberwo:18367

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  1. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, 04.
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Cited by:
  1. Philipp K├Ânig & David Pothier, 2014. "Asymmetric Information and Roll-Over Risk," Discussion Papers of DIW Berlin 1364, DIW Berlin, German Institute for Economic Research.
  2. Choi, Jaewon & Hackbarth, Dirk & Zechner, Josef, 2013. "Granularity of corporate debt," CFS Working Paper Series 2013/26, Center for Financial Studies (CFS).

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