Working Paper: NBER ID: w18367
Authors: Hui Chen; Yu Xu; Jun Yang
Abstract: We build a dynamic capital structure model to study the link between firms' systematic risk exposures and their time-varying debt maturity choices, as well as its implications for the term structure of credit spreads. Compared to short-term debt, long-term debt helps reduce rollover risks, but its illiquidity raises the costs of financing. With both default risk and liquidity costs changing over the business cycle, our calibrated model implies that debt maturity is pro-cyclical, firms with high systematic risk favor longer debt maturity, and that these firms will have more stable maturity structures over the cycle. Moreover, pro-cyclical maturity variation can significantly amplify the impact of aggregate shocks on the term structure of credit spreads, especially for firms with high beta, high leverage, or a lumpy maturity structure. We provide empirical evidence for the model predictions on both debt maturity and credit spreads.
Keywords: systematic risk; debt maturity; credit spreads
JEL Codes: E32; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High systematic risk exposures (G32) | Longer debt maturities (H63) |
| Longer debt maturities (H63) | Reduced rollover risks (G51) |
| Procyclical maturity variation (E32) | Amplified fluctuations in credit spreads (E32) |
| High leverage/systematic risk (G32) | Amplified fluctuations in credit spreads (E32) |
| Reduction in debt maturity (G32) | Significant increase in credit spreads (G19) |
| Sensitivity of debt maturity to systematic risk (G12) | More pronounced credit spread fluctuations (G19) |
| High systematic risk (G32) | More stable maturity structures (G19) |
| One-standard-deviation increase in asset market beta (G19) | Significant raise in long-term debt share (G32) |