Changes in collateralization have been implicated in significant default (or near-default) events during the financial crisis, most notably with AIG. We have developed a framework for quantifying this effect based on moving between Merton-type and Black-Cox-type structural default models. Our...

Fama and French (1992) suggest that the positive value premium results from risk of financial distress. However, recent empirical research has found that financially distressed firms have lower stock returns, using empirical estimates of default probabilities. This paper reconciles the positive...

We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk amplifies aggregate technology shocks. The debt-capital ratio is a new state variable and its endogenous movements provide a propagation mechanism....

Fama and French (1992) suggest that the positive value premium results from financial distress risk. However, recent empirical research finds that financially distressed firms have lower stock returns, by using empirical estimates of default probabilities. This paper reconciles the positive...

We incorporate long-term defaultable corporate bonds and credit risk in a dynamic stochastic general equilibrium business cycle model. Credit risk amplifies aggregate technology shocks. The debt-capital ratio is a new state variable and its endogenous movements provide a propagation mechanism....

I propose a neoclassical production economy with costly external financing, partial investment irreversibility, and endogenous investment/financing decisions to rationalize and quantify the well-documented interaction between the book-to-market equity effect and the financial leverage effect in...

Campbell, Hilscher, and Szilagyi (2008) show that firms with a high probability of default have significantly low average future returns. We show that there is a large overlap between stocks classified as high default risk, and those that are likely to produce extremely high returns over the...

I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise...

The investment premium -- the finding that firms with low asset growth deliver high average returns -- is an integral part of recent factor models. I document empirically that the investment premium (1) reflects leverage, (2) does not exist among zero-leverage firms, and (3) increases with...

This paper shows that the optimal leverage decreases with asset volatility risk in a trade-off framework. Thus, the paper relates the asset volatility risk premium to the underleverage puzzle. In models without volatility risk, the paper empirically documents that underleverage increases with...