Vanishing Contagion Spreads

Diogo Duarte (), Rodolfo Prieto (), Marcel Rindisbacher and Yuri F. Saporito ()
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Diogo Duarte: Florida International University, Miami, Florida 33199
Rodolfo Prieto: INSEAD, 77300 Fontainebleau, France
Yuri F. Saporito: Fundação Getulio Vargas, Rio de Janeiro - RJ, 22640-102, Brazil

Management Science, 2022, vol. 68, issue 1, 740-772

Abstract: We study default in a multifirm equilibrium setting with incomplete information. Defaults are consistent with the firm’s balance sheet and aggregation. We show that the endogenous volatility and jump size of debt and equity generated by other firms’ shocks vanish as the number of firms in the economy increases. As a result, credit spreads depend asymptotically only on the firms’ own cash flow risk. Our vanishing contagion spread result calls into question recent findings based on production economies, in which quantities of risk (volatilities and jump sizes of securities) are specified exogenously, that attribute credit spreads mostly to contagion.

Keywords: credit spreads; contagion; exchange economy; incomplete information; risk premia representation (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:1:p:740-772

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