NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Dynamic Dispersed Information and the Credit Spread Puzzle

Elias Albagli, Christian Hellwig, Aleh Tsyvinski

NBER Working Paper No. 19788
Issued in January 2014
NBER Program(s):   AP   EFG

We develop a dynamic nonlinear, noisy REE model of credit risk pricing under dispersed information that can theoretically and quantitatively account for the credit spread puzzle. The first contribution is a sharp analytical characterization of the dynamic REE equilibrium and its comparative statics. Second, we show that the nonlinearity of the bond payoff in the environment with dispersed information and limits to arbitrage leads to underpricing of corporate debt and to spreads that over-state the probability of default. This underpricing is most pronounced for high investment grade, short maturity bonds. Third, we calibrate to the empirical data on the belief dispersion and show that the model generates spreads that explain between 16 to 42% of the empirical values for 4-year high investment grade, and 35 to 46% for 10-year, high investment grade bonds. These magnitudes are in line with empirical estimates linking bond spreads to empirical measures of investor disagreement, and substantially higher than most structural models of credit risk. The primary contribution of our paper in moving NREE models towards a more realistic asset pricing environment -- dynamic, nonlinear, and quantitative -- that holds significant promise for explaining empirical asset pricing puzzles.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

Information about Free Papers

You should expect a free download if you are a subscriber, a corporate associate of the NBER, a journalist, an employee of the U.S. federal government with a ".GOV" domain name, or a resident of nearly any developing country or transition economy.

If you usually get free papers at work/university but do not at home, you can either connect to your work VPN or proxy (if any) or elect to have a link to the paper emailed to your work email address below. The email address must be connected to a subscribing college, university, or other subscribing institution. Gmail and other free email addresses will not have access.

E-mail:

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w19788

Users who downloaded this paper also downloaded these:
Bekaert, Harvey, Lundblad, and Siegel w19786 Political Risk Spreads
Vavra w19790 Time-Varying Phillips Curves
Albagli, Hellwig, and Tsyvinski w17548 A Theory of Asset Pricing Based on Heterogeneous Information
Michaillat and Saez w19777 An Economical Business-Cycle Model
Kelly, Pastor, and Veronesi w19812 The Price of Political Uncertainty: Theory and Evidence from the Option Market
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us