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Economic uncertainty, disagreement, and credit markets

Buraschi, Andrea and Trojani, Fabio and Vedolin, Andrea (2011) Economic uncertainty, disagreement, and credit markets. . (Unpublished)

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Abstract

We study the link between credit spreads and the heterogeneous formation of expectations in an economy where agents with different perception of economic uncertainty disagree about future cash flows of a defaultable firm. The intertemporal risk-sharing of disagreeing investors gives rise to three testable implications: First, larger belief heterogeneity increases credit spreads and their volatility. Second, it implies a higher frequency of capital structure arbitrage violations. Third, it reduces expected equity returns of low levered firms, but the link can be reversed for high levered firms. We use a data-set of firm-level differences in beliefs, credit spreads, and stock returns to empirically test these predictions. The economic and statistical significance of the intertemporal risk-sharing channel of disagreement is substantial and robust to the inclusion of control variables such as Fama and French, liquidity, and implied volatility factors.

Item Type: Monograph (Working Paper)
Additional Information: © 2011 The authors
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
Sets: Departments > Finance
Collections > Economists Online
Date Deposited: 16 Apr 2012 10:32
Last Modified: 16 Apr 2012 10:58
URI: http://eprints.lse.ac.uk/id/eprint/43092

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