Long Run Risks, Credit Markets, and Financial Structure

American Economic Review P&P 100 (2), 2010, pp. 547-551

In this paper we explore the impact of long run risks in cash ow and consumption growth on optimal corporate default and capital structure decisions, the term structure of credit spreads and actual default probabilities, and the levered equity risk premium. We do this by embedding a structural model of credit risk and dynamic corporate nancing decisions in a consumption-based representative-agent asset pricing model. The resulting uni ed framework has the advantage that it can be used to study the interplay between corporate nance and asset pricing.