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Growth options, macroeconomic conditions, and the cross section of credit risk

  • Arnold, Marc
  • Wagner, Alexander F.
  • Westermann, Ramona

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared with firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross section of all these features.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 107 (2013)
Issue (Month): 2 ()
Pages: 350-385

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Handle: RePEc:eee:jfinec:v:107:y:2013:i:2:p:350-385
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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