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Vanishing Contagion Spreads

Author

Listed:
  • Diogo Duarte

    (Florida International University, Miami, Florida 33199)

  • Rodolfo Prieto

    (INSEAD, 77300 Fontainebleau, France)

  • Marcel Rindisbacher

    (Boston University, Boston, Massachussetts 02215)

  • Yuri F. Saporito

    (Fundação Getulio Vargas, Rio de Janeiro - RJ, 22640-102, Brazil)

Abstract

We study default in a multifirm equilibrium setting with incomplete information. Defaults are consistent with the firm’s balance sheet and aggregation. We show that the endogenous volatility and jump size of debt and equity generated by other firms’ shocks vanish as the number of firms in the economy increases. As a result, credit spreads depend asymptotically only on the firms’ own cash flow risk. Our vanishing contagion spread result calls into question recent findings based on production economies, in which quantities of risk (volatilities and jump sizes of securities) are specified exogenously, that attribute credit spreads mostly to contagion.

Suggested Citation

  • Diogo Duarte & Rodolfo Prieto & Marcel Rindisbacher & Yuri F. Saporito, 2022. "Vanishing Contagion Spreads," Management Science, INFORMS, vol. 68(1), pages 740-772, January.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:1:p:740-772
    DOI: 10.1287/mnsc.2020.3868
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    References listed on IDEAS

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