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Asset Prices and Default-Free Term Structure in an Equilibrium Model of Default

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  • Ganlin Chang

    (Columbia University)

Abstract

We present an equilibrium production economy in which default occurs in equilibrium. The borrower chooses optimal default and consumption policies, taking into account that default is costly and the lender gains access to the technology upon default. We derive asset prices and default premia in this economy. The borrower's relative risk aversion in wealth increases with decreases in wealth due to the increased possibility of default at low wealth levels. This produces a time-varying pricing kernel and a countercyclical equity premium. We thus provide an equilibrium rationale for the default premium to influence expected asset returns.

Suggested Citation

  • Ganlin Chang, 2005. "Asset Prices and Default-Free Term Structure in an Equilibrium Model of Default," The Journal of Business, University of Chicago Press, vol. 78(3), pages 997-1022, May.
    • Handle: RePEc:ucp:jnlbus:v:78:y:2005:i:3:p:997-1022
    DOI: 10.1086/429651
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    Cited by:

    1. Alexandros P. Bechlioulis & Sophocles N. Brissimis, 2020. "Consumer default and optimal consumption decisions," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 48(5), pages 1020-1034, September.
    2. Alexandros P. Bechlioulis & Sophocles N. Brissimis, 2021. "Are household consumption decisions affected by past due unsecured debt? Theory and evidence," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 3040-3053, April.
    3. Ben-zhang Yang & Xinjiang He & Nan-jing Huang, 2019. "Equilibrium price and optimal insider trading strategy under stochastic liquidity with long memory," Papers 1901.00345, arXiv.org, revised Jan 2019.
    4. Dragon Tang & Hong Yan, 2006. "Macroeconomic Conditions, Firm Characteristics, and Credit Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 177-210, June.
    5. Aneel Keswani, 2005. "Estimating A Risky Term Structure Of Brady Bonds," Manchester School, University of Manchester, vol. 73(s1), pages 99-127, September.

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