Macroeconomic Conditions, Growth Options and the Cross-Section of Credit Risk

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, in-corporating the fact that ¯rms are heterogeneous in their asset composition. Compared to ¯rmswhich are mainly composed of invested assets, ¯rms with growth options have larger costs ofdebt because they are more volatile and have a higher tendency to default during recession whenmarginal utility is high and recovery rates are low. Our model matches stylized facts regardingcredit spreads, default probabilities, leverage, and investment clustering. Importantly, it alsomakes predictions about the cross-section of all these features.