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Credit risk and Disaster risk

  • Francois Gourio

    (Boston University)

Credit spreads are large, volatile, and countercyclical, and recent empirical work suggests that risk premia, not expected credit losses, are responsible for these features. Building on the idea that corporate debt, while fairly safe in ordinary recessions, is exposed to economic depressions, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, exogenously timevarying risk of economic disaster. The model replicates the level, volatility and cyclicality of credit spreads, and variation in the corporate bond risk premium amplifies macroeconomic fluctuations in investment, employment, and GDP.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 112.

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Date of creation: 2010
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Handle: RePEc:red:sed010:112
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