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Equilibrium Asset Pricing with Leverage and Default
Author(s) -
GOMES JOÃO F.,
SCHMID LUKAS
Publication year - 2021
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12987
Subject(s) - leverage (statistics) , volatility (finance) , economics , capital asset pricing model , risk premium , monetary economics , debt , general equilibrium theory , value premium , financial economics , econometrics , microeconomics , finance , machine learning , computer science
We develop a general equilibrium model linking the pricing of stocks and corporate bonds to endogenous movements in corporate leverage and aggregate volatility. The model features heterogeneous firms making optimal investment and financing decisions and connects fluctuations in macroeconomic quantities and asset prices to movements in the cross section of firms. Empirically plausible movements in leverage produce realistic asset return dynamics. Countercyclical leverage drives predictable variation in risk premia, and debt‐financed growth generates a high value premium. Endogenous default produces countercyclical aggregate volatility and credit spread movements that are propagated to the real economy through their effects on investment and output.