We show that the slight possibility of a macroeconomic disaster of moderate magnitude can explain important features across credit, option, and equity markets. Our consumption-based equilibrium model captures the empirical level and volatility of credit spreads, generates a flexible credit term...

This article studies the pricing implications of learning about arrivals of economic disasters and the subsequent recoveries. We model a disaster as a separate phase, and transitions between the disaster and the normal phase introduce structual changes to the consumption process which triggers...