Credit spreads are large, volatile and countercyclical, and recent empirical work suggests that risk premia, not … recessions, is exposed to economic depressions, this paper embeds a trade-off theory of capital structure into a real business … cycle model with a small, exogenously time-varying risk of economic disaster. The model replicates the level, volatility and …

aggregate risk premia. Building on the idea that corporate debt, while safe in normal times, is exposed to the risk of economic … depression, this paper embeds a trade-off theory of capital structure into a real business cycle model with a small, time …-varying risk of large economic disaster. This simple feature generates large, volatile and countercyclical credit spreads as well …

We examine asset prices in a representative-agent model of general equilibrium. Assuming only that individuals are risk … averse, we determine conditions on the changes in asset risk that are both necessary and sufficientfor the asset price to … incomplete in the sense of containing an uninsurable background risk, such as a risk on labor income. We extend our model to show …