Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

By Hui Chi Chen. 2010

674 citations recorded by the source corpus.

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.

Subfields: Accounting, Finance

View Paper: https://www.semanticscholar.org/paper/10501ad00c34f1e14cb200471f0f333f6ec668f9

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Citations in the corpus

Firm Financing over the Business Cycle (2018, positive): “We discretize the shocks using the standard method by Tauchen (1990). Given a parametrization, we nd the policies and the value functions of entrants and incumbents by value function iterations.”
The expected cost of default (2016, methodology): “The solution technique follows that of Chen (2010) which is based on a method of pricing options on securities with Markov-modulated dynamics presented in Jobert and Rogers (2006).”
Credit Risk and Disaster Risk (2013, positive): “Fourth, the paper relates to the vast literature on the credit spread puzzle (e.g. Leland (1994), Huang and Huang (2003), Hackbardt, Miao and Morellec (2006), Chen (2010), Chen, Collin Dufresne and Goldstein (2009), and Bhamra, Kuehn and Strebulaev (2009a, 2009b)).”
Credit Default Swaps: A Survey (2014, background): “In a Federal Reserve Bank of New York staff report, Chen et al. [2011] document a three-month sample from May 1, to July 31, 2010 including 29,146 single-name sovereign CDS transactions for 74 reference names.”
A theory of corporate financial decisions with liquidity and solvency concerns (2011, positive): “Macroeconomic risk has been recently successfully incorporated into contingent claims models of capital structure (Hackbarth, Miao, and Morellec, 2006; Bhamra, Kuehn, and Strebulaev, 2010; Chen, 2010) and may also have an important impact on corporate liquidity and solvency risks and their interacti”
Paulson's Gift (2010, background): “9 The historical average recovery rate of bonds is about 40%, but it declines to about 20% during recessions (see e.g. Chen (2008)).”
Macroeconomic Risk and Hedge Fund Returns (2014, background): “test macro-timing ability of hedge funds and mutual funds, so this particular analysis can be viewed as a generalization of the Cao, Chen, Liang, and Lo (2013) results using a broader set of newly proposed macroeconomic risk factors.”
Rollover Risk and Credit Risk (2012, neutral): “, Chen et al. (2007), and Bao et al.”
Aggregate Risk and the Choice between Cash and Lines of Credit (2010, positive): “27For example, one argument is that nancial distress costs are systematic and increase in times of high aggregate risk (see Almeida and Philippon (2007) and Chen (2010)). adjusts to the reduction in credit line demand).”
Equity Market Misvaluation, Financing, and Investment (2015, background): “It is important to note that the Bellman equation (20) does not imply that the model contains stochastic issuance costs, as in Eisfeldt and Muir (2012) or Bolton, Chen, and Wang (2013). This distinction is important for three reasons.”
Entrepreneurial Finance and Nondiversifiable Risk (2009, neutral): “6 SeeBlack and Cox(1976); Fischer, Heinkel, and Zechner (1989); and recent developments of Goldstein, Ju, and Leland(2001); Hackbarth, Miao, and Morellec (2006); andChen(2010).”