Abstract
This paper shows that standard disaster risk models are inconsistent with movements in stock market volatility and credit spreads during disasters. We resolve this shortcoming by incorporating persistent macroeconomic crises into a structural credit risk model. The model successfully captures the joint dynamics of aggregate consumption, financial leverage, and asset market risks, both unconditionally and during crises. Leverage strongly amplifies fundamental shocks by continuing to rise while crises endure. We structurally estimate the model and show that it replicates the firm-level implied volatility curve and its cross-sectional relation with observable proxies of default risk.
Original language | English (US) |
---|---|
Pages (from-to) | 2571-2616 |
Number of pages | 46 |
Journal | Review of Financial Studies |
Volume | 36 |
Issue number | 6 |
DOIs | |
State | Published - Jun 1 2023 |
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics