The Levered Equity Risk Premium and Credit Spreads: A Unified Framework

Harjoat Bhamra, Lars-Alexander Kuehn and Ilya Strebulaev

No 12827, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We embed a structural model of credit risk inside a dynamic continuous-time consumption-based asset pricing model, which allows us to price equity and corporate debt in a unified framework. Our key economic assumptions are that the first and second moments of earnings and consumption growth depend on the state of the economy which switches randomly, creating intertemporal risk, which agents prefer to resolve sooner rather than later, because they have Epstein-Zin-Weil preferences. Agents optimally choose dynamic capital structure and default times. For a dynamic cross-section of firms, our model endogenously generates a realistic average term structure and time series of actual default probabilities and credit spreads, together with a reasonable levered equity risk premium, which varies with macroeconomic conditions.

Keywords: Equity premium; Corporate bond credit spread; Predictability; Macroeconomic conditions; Jumps; Capital structure; Default (search for similar items in EconPapers)
JEL-codes: E44 G12 G32 G33 (search for similar items in EconPapers)
Date: 2018-03
New Economics Papers: this item is included in nep-cfn, nep-mac and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP12827 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: The Levered Equity Risk Premium and Credit Spreads: A Unified Framework (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:12827

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP12827

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().