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Cyclical Dispersion in Expected Defaults

Journal

Review of Financial Studies

Subject

Finance

Authors / Editors

Gomes J F;Grotteria M;Wachter J A

Biographies

Publication Year

2019

Abstract

A growing literature shows that credit indicators forecast aggregate real outcomes. While researchers have proposed various explanations, the economic mechanism behind these results remains an open question. In this paper, we show that a simple, frictionless model explains empirical findings commonly attributed to credit cycles. Our key assumption is that firms have heterogeneous exposures to underlying economy-wide shocks. This leads to endogenous dispersion in credit quality that varies over time and predicts future excess returns and real outcomes.

Available on ECCH

No


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