Interest Rates and Credit Risk∗
Interest Rates and Credit Risk∗ Carlos González-Aguado Javier Suarez Bluecap M. C. CEMFI and CEPR January 2014 Abstract This paper explores the effects of shifts in interest rates on corporate leverage and default in the context of a dynamic model in which the link between leverage and de- fault risk comes from the lower incentives of overindebted entrepreneurs to guarantee firm survival. The need to finance new investment pushes firms’ leverage ratio above some state-contingent target towards which firms gradually adjust through earnings retention. The response to interest rate rises and cuts is both asymmetric and hetero- geneously distributed across firms. Our results helps rationalize some of the evidence regarding the risk-taking channel of monetary policy. Keywords: interest rates, short-term debt, search for yield, credit risk, firm dynamics. JEL Classification: G32, G33, E52. ∗We would like to thank James Tengyu Guo for his excellent research assistance, and Oscar Arce, Arturo Bris, Andrea Caggese, Robert Kollmann, Xavier Ragot, Rafael Re- pullo, Enrique Sentana, David Webb, and the editor (Kenneth West) and two anony- mous referees for helpful comments and suggestions. The paper has also benefited from feedback from seminar participants at the 2009 European Economic Association Meet- ing, the 2010 World Congress of the Econometric Society, Banco de España, Bank of Japan, CEMFI, CNMV, European Central Bank, Instituto de Empresa, London Business School, Norges Bank, Swiss National Bank, Universidad Carlos III, Universi- dad de Navarra, the XVIII Foro de Finanzas, the JMCB conference “Macroeconomics and Financial Intermediation: Directions Since the Crisis,” and the LBS Conference on “The Macroeconomics of Financial Stability.” Suarez acknowledges support from Spanish government grant ECO2011-26308.
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