« Back to Results

Structural Models of Credit Risk

Paper Session

Saturday, Jan. 4, 2020 2:30 PM - 4:30 PM (PDT)

Manchester Grand Hyatt, Harbor A
Hosted By: American Finance Association
  • Chair: Pierre Collin-Dufresne, Swiss Federal Institute of Technology-Lausanne (EPFL)

The Global Credit Spread Puzzle

Jingzhi Huang
Pennsylvania State University
Yoshio Nozawa
Hong Kong University of Science and Technology
Zhan Shi
Tsinghua University


Using security-level credit spread data in eight developed economies, we document a large cross-country
difference in credit spreads conditional on credit ratings and other default risk measures. The standard benchmark structural models not only have difficulty matching credit spreads but also fail to explain the cross-country variation in spreads as well as the dynamic behavior of credit spreads. Since this cross-country variation is positively related to illiquidity measures, we implement an extended structural model that incorporates endogenous liquidity in the secondary market, and find that this model largely explains credit spreads in cross sections and over time. Therefore, default risk itself unlikely explains corporate credit spreads.

A Unified Model of Distress Risk Puzzles

Zhiyao Chen
Chinese University of Hong Kong
Dirk Hackbarth
Boston University
Ilya Strebulaev
Stanford University


We build a dynamic model to link two empirical patterns: the negative failure probability-return relation (Campbell, Hilscher, and Szilagyi, JF, 2008) and the positive distress risk premium-return relation (Friewald, Wagner, and Zechner, JF, 2014). We show analytically and quantitatively that (i) procyclical debt financing in highly distressed firms results in a negative covariance between levered equity beta with countercyclical market risk premium; (ii) the negative covariance generates low or negative stock returns and alphas among those highly distressed firms in the conditional CAPM; and (iii) firms with lower distress risk premiums endogenously choose higher leverage, so they are more likely to become distressed and earn negative returns. We provide empirical evidence to support our model predictions.

Same Firm, Different Betas

Ryan Lewis
University of Colorado Boulder


Models of integrated asset markets predict that the debt and equity of the same firm have similar exposure to systematic risk. However, controlling for default probability, firms with a higher proportion of asset level systematic risk do not have commensurately higher spreads on either their vanilla bonds or synthetic bonds derived from option prices. More, the equity and debt of a firm do not share correlated factor exposures or model expected returns as predicted in this class of models. In line with extent empirical asset pricing research, systematic risk proportion does explain credit spreads when estimated from a firm’s bond returns. These results do not appear to be driven by differential exposure to volatility shocks and support a segmented markets approach to modeling the firm.

The Risks of Safe Assets

Yang Liu
University of Hong Kong
Lukas Schmid
Duke University
Amir Yaron
University of Pennsylvania


US government bonds exhibit many characteristics often attributed to safe assets: They are very liquid and lenders readily accept them as collateral. Indeed, a growing literature documents significant convenience yields, perhaps due to liquidity, in scarce US Treasuries, suggesting that rising Treasury supply and government debt comes with a declining liquidity premium and a fall in firms' relative cost of debt financing. In this paper, we empirically document a dual role for government debt. Through a liquidity channel, an increase in government debt improves liquidity and lowers liquidity premia by facilitating debt rollover, thereby reducing credit spreads. Through an uncertainty channel, however, rising government debt creates policy uncertainty, raising credit spreads and default risk premia. We interpret and quantitatively evaluate these two channels through the lens of a general equilibrium asset pricing model with risk-sensitive agents subject to liquidity shocks, in which firms issue defaultable bonds and the government issues tax-financed bonds that endogenously enjoy liquidity benefits. The calibrated model generates quantitatively realistic liquidity spreads and default risk premia, in line with historical US debt policies and low corporate default rates. Quantitatively, our model suggests that while rising government debt reduces liquidity spreads, it not only crowds out corporate debt financing, and therefore, investment, but also creates uncertainty reflected in endogenous tax volatility, credit spreads, and risk premia, and ultimately consumption volatility. Therefore, increasing safe asset supply can be risky.
Peter Feldhütter
Copenhagen Business School
Kent Daniel
Columbia University
Antje Berndt
Australian National University
Lars Lochstoer
University of California-Los Angeles
JEL Classifications
  • G1 - General Financial Markets