Abstract - Equilibrium Credit Spreads and the Macroeconomy

The Great Recession of 2008 offers a primary example of the important role that fluctuations in credit risk play in the aggregate economy. In this paper we explore this link with a tractable general equilibrium asset pricing model with heterogeneous firms. Our model produces realistic movements in risk premia in equity and corporate bond markets and shows how this is an important determinant of aggregate fluctuations following both technology and pure credit shocks. We also show that movements in credit spreads forecast recessions by predicting future movements in corporate investment.

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