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Credit Risk and Business Cycles

Author

Listed:
  • Jianjun Miao

    (Department of Economics, Boston University, CEMA, Central University of Finance and Economics, and AFR, Zhejiang University)

  • PENGFEI WANG

    (Department of Economics, Hong Kong University of Science and Technology, ClearWater Bay, Hong Kong.)

Abstract

We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk ampli¯es aggregate tech- nology shocks. The debt-capital ratio is a new state variable and its endogenous movements provide a propagation mechanism. The model can match the persistence and volatility of output growth as well as the mean equity premium and the mean risk-free rate as in the data. The model implied credit spreads are countercyclical and forecast future economic activities because they a®ect ¯rm investment through Tobin's Q. They also forecast future stock returns through changes in the market price of risk. Finally, we show that ¯nancial shocks to the credit markets are transmitted to the real economy through Tobin's Q.

Suggested Citation

  • Jianjun Miao & PENGFEI WANG, 2010. "Credit Risk and Business Cycles," Boston University - Department of Economics - Working Papers Series WP2010-033, Boston University - Department of Economics.
    • Handle: RePEc:bos:wpaper:wp2010-032
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    References listed on IDEAS

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    3. Vincenzo Quadrini, 2011. "Financial frictions in macroeconomic fluctations," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 97(3Q), pages 209-254.
    4. François Gourio, 2013. "Credit Risk and Disaster Risk," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 1-34, July.
    5. repec:fip:fedreq:y:2011:i:3q:p:209-254:n:vol.97no.3 is not listed on IDEAS
    6. Hui Chen & Gustavo Manso, 2017. "Macroeconomic Risk and Debt Overhang," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 6(1), pages 1-38.
    7. Pengfei Wang & Jianjun Miao, 2011. "Bubbles and Credit Constraints," 2011 Meeting Papers 94, Society for Economic Dynamics.
    8. João Gomes & Urban Jermann & Lukas Schmid, 2016. "Sticky Leverage," American Economic Review, American Economic Association, vol. 106(12), pages 3800-3828, December.
    9. Okimoto, Tatsuyoshi & Takaoka, Sumiko, 2017. "The term structure of credit spreads and business cycle in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 45(C), pages 27-36.
    10. Tao Shen, 2017. "Credit spreads and investment opportunities," Review of Quantitative Finance and Accounting, Springer, vol. 48(1), pages 117-152, January.
    11. João F. Gomes & Lukas Schmid, 2021. "Equilibrium Asset Pricing with Leverage and Default," Journal of Finance, American Finance Association, vol. 76(2), pages 977-1018, April.
    12. Cui, Wei & Kaas, Leo, 2021. "Default cycles," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 377-394.
    13. Shang-Jin Wei & Jing Zhou, 2018. "Quality of Public Governance and the Capital Structure of Nations and Firms," NBER Working Papers 24184, National Bureau of Economic Research, Inc.
    14. Alex Carrasco & David Florian Hoyle & Rafael Nivin, 2019. "SFX Interventions, Financial Intermediation, and External Shocks in Emerging Economies," Working Papers 160, Peruvian Economic Association.
    15. Gourio, François, 2012. "Macroeconomic implications of time-varying risk premia," Working Paper Series 1463, European Central Bank.
    16. Joachim Jungherr & Immo Schott, 2021. "Optimal Debt Maturity and Firm Investment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 42, pages 110-132, October.
    17. Gertler, Mark & Kiyotaki, Nobuhiro & Queralto, Albert, 2012. "Financial crises, bank risk exposure and government financial policy," Journal of Monetary Economics, Elsevier, vol. 59(S), pages 17-34.
    18. Yang Liu & Amir Yaron & Lukas Schmid, 2019. "The Risks of Safe Assets," 2019 Meeting Papers 1418, Society for Economic Dynamics.
    19. Julio Blanco & Gaston Navarro, 2016. "The Unemployment Accelerator," CESifo Working Paper Series 6248, CESifo.

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    More about this item

    Keywords

    credit risk; credit spread; dynamic capital structure; equity premium; business cycles; investment; q-theory;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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