THESIS
2019
vii, 69 pages : illustrations ; 30 cm
Abstract
This paper studies the asset pricing implications of idiosyncratic tail risk on credit
spread. I propose a model featuring an incomplete market, heterogeneous households
with recursive preference, and comovement of tail risk in labor income and firm-level
cash
flow growth. The model produces strong covariation between households' marginal
utility and default rates, which helps to explain the stylized fact that the credit spread (1)
is on average large and (2) is positively related to labor-income tail risk. Quantitatively,
the tail risk premium accounts for as much as 68% of the observed credit spread. My
framework also provides a new insight, drawn from an option perspective, that the
implications of idiosyncratic tail risk for stocks and bonds can be very different....[
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This paper studies the asset pricing implications of idiosyncratic tail risk on credit
spread. I propose a model featuring an incomplete market, heterogeneous households
with recursive preference, and comovement of tail risk in labor income and firm-level
cash
flow growth. The model produces strong covariation between households' marginal
utility and default rates, which helps to explain the stylized fact that the credit spread (1)
is on average large and (2) is positively related to labor-income tail risk. Quantitatively,
the tail risk premium accounts for as much as 68% of the observed credit spread. My
framework also provides a new insight, drawn from an option perspective, that the
implications of idiosyncratic tail risk for stocks and bonds can be very different.
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