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Credit Risk and Disaster Risk

  • Francois Gourio

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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17026.

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Date of creation: May 2011
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Publication status: published as François Gourio, 2013. "Credit Risk and Disaster Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 1-34, July.
Handle: RePEc:nbr:nberwo:17026
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