IFin Seminar, Peter Feldhütter, Copenhagen Business School - "Debt dynamics and credit risk"
Institute of Finance
Date: 7 April 2022 / 12:25 - 13:40
Speaker: Peter Feldhütter, Copenhagen Business School
Title: "Debt dynamics and credit risk"
Date: April 7, 2022
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 debt dynamics into an otherwise standard structural model and compare the model’s ability to match the cross-section of US credit spreads with that of existing models. The model provides more accurate predictions of credit spreads in both the cross-section and the time series, particularly for shortmaturity debt.