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Credit risk and Disaster risk

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  • Francois Gourio

    (Boston University)

Abstract

Corporate credit spreads are large, volatile, countercyclical, and significantly larger than expected losses, but existing macroeconomic models with financial frictions fail to reproduce these patterns, because they imply small and constant aggregate risk premia. Building on the idea that corporate debt, while safe in normal times, is exposed to the risk of economic depression, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, time-varying risk of large economic disaster. This simple feature generates large, volatile and countercyclical credit spreads as well as novel business cycle implications. In particular, financial frictions substantially amplify the effect of shocks to the disaster probability.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 112.

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Date of creation: 2010
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Handle: RePEc:red:sed010:112

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Cited by:
  1. Sylvain Leduc & Zheng Liu, 2012. "Uncertainty shocks are aggregate demand shocks," Working Paper Series 2012-10, Federal Reserve Bank of San Francisco.
  2. 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.
  3. 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.
  4. Robert J. Barro & José F. Ursúa, 2012. "Rare Macroeconomic Disasters," Annual Review of Economics, Annual Reviews, vol. 4(1), pages 83-109, 07.
  5. Martin Schneider & Cosmin Ilut & Francesco Bianchi, 2013. "Uncertainty Shocks, Asset Supply and Pricing over the Business Cycle," 2013 Meeting Papers 202, Society for Economic Dynamics.
  6. 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.
  7. Sylvain, Serginio, 2014. "Does Human Capital Risk Explain The Value Premium Puzzle?," MPRA Paper 54551, University Library of Munich, Germany.
  8. 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.
  9. 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.
  10. 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.
  11. 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.
  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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