We propose an explanation for default contagion based on a Lucas model with two independent debt-financed trees. The transmission mechanism is that variations in the size of one tree impact the level of risk premium and the default decision for all borrowers. If a negative shock hits one tree,...

We show that firm default risk is the primary predictor of the comovement between corporate bond and stock returns, both in the cross-section and over time. Intuitively, bonds of less creditworthy firms behave more like the issuing firms’ stocks, resulting in higher future comovement. We find...