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Growth options, macroeconomic conditions, and the cross section of credit risk


Arnold, Marc; Wagner, Alexander F; Westermann, Ramona (2013). Growth options, macroeconomic conditions, and the cross section of credit risk. Journal of Financial Economics, 107(2):350-385.

Abstract

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared with firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross section of all these features.

Abstract

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared with firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross section of all these features.

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19 citations in Web of Science®
21 citations in Scopus®
23 citations in Microsoft Academic
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:1 February 2013
Deposited On:13 Feb 2014 09:56
Last Modified:24 Sep 2019 20:10
Publisher:Elsevier
ISSN:0304-405X
OA Status:Green
Free access at:Related URL. An embargo period may apply.
Publisher DOI:https://doi.org/10.1016/j.jfineco.2012.08.017
Related URLs:https://www.sciencedirect.com/science/article/pii/S0304405X12001821?via%3Dihub (Publisher)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1570353
Other Identification Number:merlin-id:9200

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