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...

The lack of collateralized trading in the OTC derivatives market and the absence of any system for the resolution of cross exposures have been highlighted as major causes of the collapse of assets prices during the financial crisis. According to the perfect market hypothesis derivatives are a...