Dynamic Dispersed Information and the Credit Spread Puzzle
We develop a dynamic nonlinear, noisy REE model of credit risk pricing under dispersed information that can theoretically and quantitatively account for the credit spread puzzle. The first contribution is a sharp analytical characterization of the dynamic REE equilibrium and its comparative statics. Second, we show that the nonlinearity of the bond payoff in the environment with dispersed information and limits to arbitrage leads to underpricing of corporate debt and to spreads that over-state the probability of default. This underpricing is most pronounced for high investment grade, short maturity bonds. Third, we calibrate to the empirical data on the belief dispersion and show that the model generates spreads that explain between 16 to 42% of the empirical values for 4-year high investment grade, and 35 to 46% for 10-year, high investment grade bonds. These magnitudes are in line with empirical estimates linking bond spreads to empirical measures of investor disagreement, and substantially higher than most structural models of credit risk. The primary contribution of our paper in moving NREE models towards a more realistic asset pricing environment -- dynamic, nonlinear, and quantitative -- that holds significant promise for explaining empirical asset pricing puzzles.
|Date of creation:||Jan 2014|
|Contact details of provider:|| Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.|
Web page: http://www.nber.org
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- François Gourio, 2013.
"Credit Risk and Disaster Risk,"
American Economic Journal: Macroeconomics,
American Economic Association, vol. 5(3), pages 1-34, July.
- Francois Gourio, 2010. "Credit risk and Disaster risk," 2010 Meeting Papers 112, Society for Economic Dynamics.
- Francois Gourio, 2012. "Credit risk and disaster risk," Working Paper Series WP-2012-07, Federal Reserve Bank of Chicago.
- Gourio, François, 2011. "Credit Risk and Disaster Risk," CEPR Discussion Papers 8201, C.E.P.R. Discussion Papers.
- Francois Gourio, 2011. "Credit Risk and Disaster Risk," NBER Working Papers 17026, National Bureau of Economic Research, Inc.
- Bruno Biais & Peter Bossaerts & Chester Spatt, 2010. "Equilibrium Asset Pricing and Portfolio Choice Under Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 23(4), pages 1503-1543, April.
- Biais, Bruno & Bossaerts, Peter & Spatt, Chester, 2009. "Equilibrium Asset Pricing and Portofolio Choice Under Asymmetric Information," TSE Working Papers 09-018, Toulouse School of Economics (TSE).
- Biais, Bruno & Bossaerts, Peter & Spatt, Chester, 2009. "Equilibrium Asset Pricing and Portofolio Choice Under Asymmetric Information," IDEI Working Papers 474, Institut d'Économie Industrielle (IDEI), Toulouse.
- Giesecke, Kay & Longstaff, Francis A. & Schaefer, Stephen & Strebulaev, Ilya, 2011. "Corporate bond default risk: A 150-year perspective," Journal of Financial Economics, Elsevier, vol. 102(2), pages 233-250.
- Güntay, Levent & Hackbarth, Dirk, 2010. "Corporate bond credit spreads and forecast dispersion," Journal of Banking & Finance, Elsevier, vol. 34(10), pages 2328-2345, October.
- He, Hua & Wang, Jiang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 919-972.
- Hua He and Jiang Wang., 1993. "Differential Information and Dynamic Behavior of Stock Trading Volume," Research Program in Finance Working Papers RPF-228, University of California at Berkeley.
- Hua He & Jiang Wang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," NBER Working Papers 5010, National Bureau of Economic Research, Inc.
- Wang, Jiang, 1959- & He, Hua., 1994. "Differential information and dynamic behavior of stock trading volume," Working papers 3731-94., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Masahiro Watanabe, 2008. "Price Volatility and Investor Behavior in an Overlapping Generations Model with Information Asymmetry," Journal of Finance, American Finance Association, vol. 63(1), pages 229-272, 02.
- Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
- Laura L. Veldkamp, 2011. "Information Choice in Macroeconomics and Finance," Economics Books, Princeton University Press, edition 1, number 9621, March.
- Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
- Xavier Gabaix, 2008. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," NBER Working Papers 13724, National Bureau of Economic Research, Inc.
- Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2011. "A Theory of Asset Pricing Based on Heterogeneous Information," NBER Working Papers 17548, National Bureau of Economic Research, Inc.
- Kay Giesecke & Francis A. Longstaff & Stephen Schaefer & Ilya Strebulaev, 2010. "Corporate Bond Default Risk: A 150-Year Perspective," NBER Working Papers 15848, National Bureau of Economic Research, Inc.
- Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
- Long Chen & Pierre Collin-Dufresne & Robert S. Goldstein, 2009. "On the Relation Between the Credit Spread Puzzle and the Equity Premium Puzzle," Review of Financial Studies, Society for Financial Studies, vol. 22(9), pages 3367-3409, September.
- Snehal Banerjee, 2011. "Learning from Prices and the Dispersion in Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 24(9), pages 3025-3068.
- Yu, Fan, 2005. "Accounting transparency and the term structure of credit spreads," Journal of Financial Economics, Elsevier, vol. 75(1), pages 53-84, January.
- Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-168, February.
- Timothy C. Johnson, 2004. "Forecast Dispersion and the Cross Section of Expected Returns," Journal of Finance, American Finance Association, vol. 59(5), pages 1957-1978, October.
- Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-588, August.
- Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
- J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:19788. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.