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Default cycles

Cui, Wei and Kaas, Leo (2017) Default cycles. CFM discussion paper series (CFM-DP2017-16). Centre For Macroeconomics, London, UK.

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Abstract

Recessions are often accompanied by spikes of corporate default and prolonged declines of business credit. This paper argues that credit and default cycles are the outcomes of variations in self-fulfilling beliefs about credit market conditions. We develop a tractable macroeconomic model in which leverage ratios and interest spreads are determined in optimal credit contracts that reflect the expected default risk of borrowing firms. We calibrate the model to evaluate the impact of sunspots and fundamental shocks on the credit market and on output dynamics. Self-fulfilling changes in credit market expectations trigger sizable reactions in default rates and generate endogenously persistent credit and output cycles. All credit market shocks together account for about 50% of the variation of U.S. output growth during 1982–2015.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.centreformacroeconomics.ac.uk/Home.aspx
Additional Information: © 2017 The Authors
Divisions: Centre for Macroeconomics
Subjects: H Social Sciences > HB Economic Theory
JEL classification: E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Employment, and Investment > E22 - Capital; Investment (including Inventories); Capacity
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
Sets: Research centres and groups > Centre for Macroeconomics
Date Deposited: 12 Dec 2017 10:00
Last Modified: 05 Aug 2020 23:09
URI: http://eprints.lse.ac.uk/id/eprint/86159

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