The authors develop a simple binomial model of liquidity and credit risk in which a bondholder has the option to time the sale of his security, given a distribution of potential buyers, bids and liquidity shocks.

Structural credit risk models have faced difficulties in matching observed market credit spreads while simultaneously matching default rates, recoveries, leverage and risk premia - a shortcoming that has become known as the credit spread puzzle. We ask whether stochastic asset volatility, as an...

Structural credit risk models have faced difficulties in matching observed market credit spreads while simultaneously matching default rates, recoveries, leverage and risk premia - a shortcoming that has become known as the credit spread puzzle. We ask whether stochastic asset volatility, as an...

Structural credit risk models have faced difficulties in matching observed market credit spreads while simultaneously matching default rates, recoveries, leverage and risk premia - a shortcoming that has become known as the credit spread puzzle. We ask whether stochastic asset volatility, as an...

We propose an explanation for default contagion based on a Lucas model with two independent debt-financed trees. The transmission mechanism is that variations in the size of one tree impact the level of risk premium and the default decision for all borrowers. If a negative shock hits one tree,...