Systematic Risk, Debt Maturity, and the Term Structure of Credit Spreads
We build a dynamic capital structure model to study the link between firms' systematic risk exposures and their time-varying debt maturity choices, as well as its implications for the term structure of credit spreads. Compared to short-term debt, long-term debt helps reduce rollover risks, but its illiquidity raises the costs of financing. With both default risk and liquidity costs changing over the business cycle, our calibrated model implies that debt maturity is pro-cyclical, firms with high systematic risk favor longer debt maturity, and that these firms will have more stable maturity structures over the cycle. Moreover, pro-cyclical maturity variation can significantly amplify the impact of aggregate shocks on the term structure of credit spreads, especially for firms with high beta, high leverage, or a lumpy maturity structure. We provide empirical evidence for the model predictions on both debt maturity and credit spreads.
We thank Viral Acharya, Heitor Almeida, Jennifer Carpenter, Chris Hennessy, Burton Hollield, Nengjiu Ju, Thorsten Koeppl, Leonid Kogan, Jun Pan, Monika Piazzesi, Ilya Strebulaev, Wei Xiong and seminar participants at the NBER Asset Pricing Meeting, Texas Finance Festival, China International Conference in Finance, Summer Institute of Finance Conference, Bank of Canada Fellowship Workshop, London School of Economics, and London Business School for comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.