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Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

Author(s)
Chen, Hui
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Creative Commons Attribution-Noncommercial-Share Alike 3.0 http://creativecommons.org/licenses/by-nc-sa/3.0/
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Abstract
I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms’ financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms’ responses to the macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the “credit spread puzzle” and “under-leverage puzzle” in a unified framework. The model generates interesting dynamics for financing and defaults, including “credit contagion” and market timing of debt issuance. It also provides a novel procedure to estimate state-dependent default losses.
Date issued
2010-11
URI
http://hdl.handle.net/1721.1/65596
Department
Sloan School of Management
Journal
Journal of Finance
Publisher
American Finance Association
Citation
Chen, Hui. “Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure.” The Journal of Finance 65.6 (2010) : 2171-2212. © 2010 the American Finance Association
Version: Author's final manuscript

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