Disastrous Defaults*

Risk premia and term premia in general equilibrium

Christian Gouriéroux, Alain Monfort, Sarah Mouabbi and Jean-Paul Renne

Review of Finance, 2021, vol. 25, issue 6, 1727-1772

Abstract: We define a disastrous default as the default of a systemic entity. Such an event is expected to have a negative effect on the economy and to be contagious. Bringing macroeconomic structure to a no-arbitrage asset-pricing framework, we exploit prices of disaster-exposed assets (credit and equity derivatives) to extract information on (i) the expected influence of a disastrous default on consumption and (ii) the probability of a financial meltdown. Using European data, we find that the returns of disaster-exposed assets are consistent with a systemic default being followed by a 2% decrease in consumption. The recessionary influence of disastrous defaults implies that financial instruments whose payoffs are exposed to such credit events carry substantial risk premiums. We also produce systemic risk indicators based on the probability of observing a certain number of systemic defaults or a sharp drop of consumption.

Keywords: Disaster risk; systemic entities; Default dependencies; Credit derivatives; Equilibrium model (search for similar items in EconPapers)
JEL-codes: E43 E44 E47 G01 G12 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Disastrous Defaults (2021)
Working Paper: Disastrous Defaults (2020)
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