Debt Dynamics and Credit Risk

Peter Feldhütter*, Stephen M. Schaefer

*Corresponding author af dette arbejde

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Abstract

We investigate how the dynamics of corporate debt policy affect the pricing of corporate bonds. We find empirically that debt issuance has a significant stochastic component that is imperfectly correlated with shocks to asset value. As a consequence, the volatility of leverage is significantly higher than asset volatility over short horizons. At long horizons, the relation between leverage and asset volatility is reversed due to mean reversion in leverage. We incorporate these stochastic debt dynamics into structural models of credit risk, both standard diffusion models as well as newer models with stochastic volatility and jumps. Including stochastic debt gives more accurate predictions of credit spreads in both the cross-section and the time series.
OriginalsprogEngelsk
TidsskriftJournal of Financial Economics
Vol/bind149
Udgave nummer3
Sider (fra-til)497-535
Antal sider39
ISSN0304-405X
DOI
StatusUdgivet - sep. 2023

Emneord

  • Structural models
  • Debt levels
  • Default rates
  • Default boundary
  • Credit risk

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