FRIC/Finance Seminar with Pietro Veronesi, University of Chicago Booth School of Business

FRIC Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Pietro Veronesi, University of Chicago Booth School of Business.

Pietro Veronesi will present

Option-Based Credit Spreads

Authors:
Christopher L. Culp, Johns Hopkins Institute for Applied Economics and Swiss Finance Institute
Yoshio Nozawa, Federal Reserve Board
Pietro Veronesi, University of Chicago

ABSTRACT
We propose a non-parametric empirical benchmark for credit risk analysis. We build fictitious “pseudo firms” that purchase real traded assets by issuing equity and zero-coupon bonds. By no-arbitrage, these bonds equal Treasuries minus put options on the firms’ assets, which are all observable. We exploit our pseudo firms as a laboratory, and empirically show that their credit spreads are large and countercyclical, illiquidity and corporate frictions are unlikely determinants of bonds’ credit spreads, infrequent rating changes and idiosyncratic asset uncertainty greatly increase spreads, and, in a banking application, discount rate shocks substantially increase banks’ tail risks and default correlations.