Review of Financial Studies Vol. 37 No. 11 2024

The Technical Default Spread

Emilio Bisetti¹; Kai Li²; Jun Yu³

¹ Hong Kong University of Science and Technology , Hong Kong SAR, · ² Peking University HSBC Business School and the PHBS Sargent Institute of Quantitative Economics and Finance , P.R. · ³ University of Melbourne

Abstract

We study the quantitative impact of lender control rights on corporate investment, asset prices, and the aggregate economy. We build a general equilibrium model in which the breaching of a loan covenant (technical default) entails a switch in investment control rights from borrowers to lenders. Lenders optimally choose low-risk projects, thus mitigating borrowers’ risk-taking incentives and lowering the cost of equity. This mechanism generates strong macroeconomic effects and mitigates the financial accelerator. Consistent with our model, proximity to technical default in the data is associated with 4.12% lower returns and lower exposure to systematic risk.

DOI

10.1093/rfs/hhae042

Volume

37

Issue

11

Pages

3386-3430

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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