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The Aggregate Dynamics of Capital Structure and Macroeconomic Risk

Harjoat S. Bhamra¹; Lars-Alexander Kuehn²; Ilya A. Strebulaev³

¹ University of British Columbia · ² Carnegie Mellon University · ³ Stanford University

We study the impact of time-varying macroeconomic conditions on optimal dynamic capital structure for a cross-section of firms. Our structural-equilibrium framework embeds a contingent-claim corporate financing model within a consumption-based asset-pricing model. We investigate the effect of macroeconomic conditions on asset valuation and optimal corporate policies, and of preferences on capital structure. While capital structure is pro-cyclical at dates when firms re-lever, it is counter-cyclical in aggregate dynamics, consistent with empirical evidence. We also find that financially constrained firms choose more pro-cyclical policies and that leverage accounts for most of the macroeconomic risk relevant for predicting defaults, but is a poor measure of how preferences impact capital structure. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

DOI

10.1093/rfs/hhq075

Volume

23 (12)

Pages

4187-4241

Language

en

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