nep-bec New Economics Papers
on Business Economics
Issue of 2010‒02‒20
twenty-six papers chosen by
Christian Calmes
Universite du Quebec en Outaouais

  1. Risk and Global Economic Architecture: Why Full Financial Integration May Be Undesirable By Joseph E. Stiglitz
  2. Conditional Correlations and Volatility Spillovers Between Crude Oil and Stock Index Returns By Tansuchat, R.; Chang, C-L.; McAleer, M.J.
  3. Bertrand competition with non-rigid capacity constraints By Prabal Roy Chowdhury
  4. Seasoned Equity Offerings by Small and Medium-Sized Enterprises By Cécile Carpentier; Jean-François L'Her; Jean-Marc Suret
  5. The Cross-Section and Time-Series of Stock and Bond Returns By Ralph S.J. Koijen; Hanno Lustig; Stijn Van Nieuwerburgh
  6. Estimating the Wage Elasticity of Labour Supply to a Firm: Is there Monopsony Down-under? By Alison L Booth; Pamela Katic
  7. The battle for talent: globalisation and the rise of executive pay By Dalia Marin
  8. Comment on "Letting different views about business cycles compete" By Jonas D. M. Fisher
  9. Unions, Monetary Shocks and the Labour Market Cycle. By Gonzalo Fernández-de-Córdoba; Jesús Vázquez
  10. Limited Capital Market Participation and Human Capital Risk By Jonathan Berk; Johan Walden
  11. Firm Heterogeneity in the Choice of Offshoring: Evidence from Korean Manufacturing Firms By Hea-Jung Hyun
  12. The Business Cycle and Health Behaviors By Xin Xu; Robert Kaestner
  13. Bankruptcy and the Collateral Channel By Efraim Benmelech; Nittai K. Bergman
  14. Does product market integration lead to decentralised wage bargaining institutions? By Michele Santoni
  15. Credit and banking in a DSGE model of the euro area By Andrea Gerali; Stefano Neri; Luca Sessa; Federico M. Signoretti
  16. Dynamic price competition with network effects By Cabral, Luis
  17. Why do (or did?) banks securitize their loans? Evidence from Italy By Massimiliano Affinito; Edoardo Tagliaferri
  18. Vintage Capital and Creditor Protection By Efraim Benmelech; Nittai K. Bergman
  19. Greasing the Wheels of International Commerce: How Services Facilitate Firms' International Sourcing By Debaere, Peter; Görg, Holger; Raff, Horst
  20. Flexible Labor and Innovation Performance: Evidence from Longitudinal Firm-Level Data By Zhou, H.; Dekker, R.; Kleinknecht, A.
  21. Information Acquisition and Price Discrimination By Fatemi, Farshad
  22. The Impact of Training on Productivity and Wages: Firm Level Evidence By Konings, Jozef; Vanormelingen, Stijn
  23. Management Practices and Firm Performance in Japanese and Korean Firms By Young Gak Kim
  24. Consumption Risk-sharing in Social Networks By Attila Ambrus; Markus Mobius; Adam Szeidl
  25. The international crisis and the Italian productive system: a firm-level study By Matteo Bugamelli; Riccardo Cristadoro; Giordano Zevi
  26. Is Credit Event Risk Priced? Modeling Contagion via the Updating of Beliefs. By Pierre Collin-Dufresne; Robert S. Goldstein; Jean Helwege

  1. By: Joseph E. Stiglitz
    Abstract: This paper provides a general framework for analyzing the optimal degree and form of financial integration. Full integration is not in general optimal: faced with a choice between two polar regimes, full integration or autarky, autarky may be superior. The intuition is simple: if underlying technologies are not convex, then risk-sharing can lower expected utility. The simplistic models arguing for financial integration typically employed in economics assume convexity; but the world is rife with non-convexities, e.g. associated with bankruptcy. The architecture of the credit market can, for instance, affect the likelihood of a bankruptcy cascade, “contagion,” and systemic risk.
    JEL: F33 F36 G32
    Date: 2010–02
  2. By: Tansuchat, R.; Chang, C-L.; McAleer, M.J. (Erasmus Econometric Institute)
    Abstract: This paper investigates the conditional correlations and volatility spillovers between crude oil returns and stock index returns. Daily returns from 2 January 1998 to 4 November 2009 of the crude oil spot, forward and futures prices from the WTI and Brent markets, and the FTSE100, NYSE, Dow Jones and S&P500 index returns, are analysed using the CCC model of Bollerslev (1990), VARMA-GARCH model of Ling and McAleer (2003), VARMA-AGARCH model of McAleer, Hoti and Chan (2008), and DCC model of Engle (2002). Based on the CCC model, the estimates of conditional correlations for returns across markets are very low, and some are not statistically significant, which means the conditional shocks are correlated only in the same market and not across markets. However, the DCC estimates of the conditional correlations are always significant. This result makes it clear that the assumption of constant conditional correlations is not supported empirically. Surprisingly, the empirical results from the VARMA-GARCH and VARMA-AGARCH models provide little evidence of volatility spillovers between the crude oil and financial markets. The evidence of asymmetric effects of negative and positive shocks of equal magnitude on the conditional variances suggests that VARMA-AGARCH is superior to VARMA-GARCH and CCC.
    Keywords: multivariate GARCH;volatility spillovers;conditional correlations;crude oil prices;spot;forward and futures prices;stock indices
    Date: 2010–02–08
  3. By: Prabal Roy Chowdhury (Indian Statistical Institute, New Delhi; Indian Statistical Institute, New Delhi)
    Abstract: We examine a model of Bertrand competition with non-rigid capacity constraints, so that by incurring an additional per unit cost of capacity expansion, firms can produce beyond capacity. We find that there is an interval of prices such that a price can be sustained as a pure strategy Nash equilibrium if and only if it lies in this interval. We then examine the properties of this set as [a] the number of firms becomes large and [b] the capacity cost increases.
    Keywords: Bertrand competition, capacity constraint
    JEL: D4 L1
    Date: 2009–01
  4. By: Cécile Carpentier; Jean-François L'Her; Jean-Marc Suret
    Abstract: Most of the analyses of small firms’ decision to seek outside equity financing and the conditions thereof have concerned private firms. Knowledge of the risk and return of entrepreneurial ventures for outside investors is consequently limited. This paper attempts to fill this gap by examining the Canadian context, where small and medium-sized enterprises (SMEs) are allowed to list on a stock market. We analyze seasoned equity offerings launched by SMEs over the last decade. These public issuers can be considered low quality firms with poor operating performance. Managers issue equity before a large decrease in operating and stock market performance. Individual investors do not price the stocks correctly around the issue and incur significant negative returns in the years following the issue. This is particularly true for constrained issuers. We confirm that entrepreneurial outside equity attracts lemons, and that individual investors cannot invest wisely in emerging ventures. Probably as a consequence of individual investors’ lack of skill and rationality, the cost of outside equity financing of Canadian public SMEs is abnormally low. <P>La plupart des analyses de la décision et des conditions de financement des petites entreprises portent sur des entités privées. Le risque et le rendement que ces entreprises représentent pour les investisseurs sont donc très mal connus. Ce papier tente de combler cette lacune en utilisant le contexte canadien, où les petites et moyennes entreprises (PMEs) sont autorisées à s’introduire en bourse. Nous analysons les financements par fonds propres levés par ces PMEs au cours de la dernière décennie. Ces émetteurs peuvent être considérés comme des entreprises de faible qualité présentant une piètre performance opérationnelle. Les dirigeants émettent des actions juste avant une forte diminution de la performance comptable et boursière. Les investisseurs individuels n’évaluent pas correctement les actions au moment de l’émission et subissent des rendements négatifs significatifs au cours des années postérieures. Ceci est particulièrement vrai pour les émetteurs contraints financièrement. Nous confirmons que le marché du financement externe des PMEs attire des « citrons », et que les investisseurs individuels ne peuvent pas investir de façon avisée dans les entreprises en développement. Conséquence probable d’un manque d’expérience et de rationalité des investisseurs individuels, le coût des fonds propres externes est anormalement bas pour les PMEs inscrites en bourse au Canada.
    Keywords: financing decision, equity offerings, small business, long-run performance, cost of equity, financial constrain, décision de financement, financement par fonds propres, petites entreprises, coût des fonds propres, performance, contrainte financière
    JEL: G14 G32 L26
    Date: 2010–01–01
  5. By: Ralph S.J. Koijen; Hanno Lustig; Stijn Van Nieuwerburgh
    Abstract: We propose an arbitrage-free stochastic discount factor (SDF) model that jointly prices the cross-section of returns on portfolios of stocks sorted on book-to-market dimension, the cross-section of government bonds sorted by maturity, the dynamics of bond yields, and time series variation in expected stock and bond returns. Its pricing factors are motivated by a decomposition of the pricing kernel into a permanent and a transitory component. Shocks to the transitory component govern the level of the term structure of interest rates and price the cross-section of bond returns. Shocks to the permanent component govern the dividend yield and price the average equity returns. Third, shocks to the relative contribution of the transitory component to the conditional variance of the SDF govern the Cochrane-Piazzesi (2005, CP) factor, a strong predictor of future bond returns. These shocks price the cross-section of book-to-market sorted stock portfolios. Because the CP factor is a strong predictor of economic activity one- to two-years ahead, positive shocks to CP signal improving economic conditions, leading to a positive price of risk. Value stocks are riskier and carry a return premium because they are more exposed to such shocks.
    JEL: E21 E43 G00 G12
    Date: 2010–01
  6. By: Alison L Booth; Pamela Katic
    Abstract: In this paper we estimate the elasticity of the labour supply to a firm, using data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey. Estimation of this elasticity is of particular interest because of its relevance to the debate about the competitiveness of labour markets. The essence of monopsonistically competitive labour markets is that labour supply to a firm is imperfectly elastic with respect to the wage rate. The intuition is that, where workers have heterogeneous preferences or face mobility costs, firms can offer lower wages without immediately losing their workforce. This is in contrast to the perfectly competitive extreme, in which the elasticity is infinite. Therefore a simple test of whether labour markets are perfectly or imperfectly competitive involves estimating the elasticity of the labour supply to a firm. We do this, following the modelling strategy of Manning (2003), and find that the Australian wage elasticity of labour supply to a firm is around 0.71, only slightly smaller than the figure of 0.75 reported for the UK. These estimates are so far from the perfectly competitive assumption of an infinite elasticity that it would be difficult to make a case that labour markets are perfectly competitive.
    Keywords: monopsony, imperfect competition, separation, labour supply elasticity
    JEL: J42 J21 J71
    Date: 2009–12
  7. By: Dalia Marin
    Abstract: This paper explores the role of globalisation in the rise of executive pay in Austria and Germany. According to Dalia Marin, firms more exposed to international competition engage in talent fairs to search and attract skilled workers. She also finds that seniority related pay varies for different levels of foreign competition suggesting that firms increase CEO pay when faced with the threat of losing their senior executives, while seniority in office itself does not lead to higher pay. These findings support the idea of a 'war for talent' that is triggered by international trade.
    Date: 2009–02
  8. By: Jonas D. M. Fisher
    Abstract: This comment explains why the findings presented in Beaudry and Lucke (2009) are misleading.
    Keywords: Technology shocks, investment-specific shocks, neutral shocks, news shocks, business cycle
    Date: 2009
  9. By: Gonzalo Fernández-de-Córdoba (Universidad de Málaga); Jesús Vázquez (Universidad del País Vasco)
    Abstract: This paper provides a new growth model by considering strategic behaviour in the supply of labour. Workers form a labour union with the aim of manipulating wages in their own benefit. We analyse the implications on labor market dynamics at business cycle frequencies of getting away from the price-taking assumption. A calibrated monetary version of the union model does quite a reasonable job in replicating the dynamic features of labour market variables observed in post-war U.S. data.
    Keywords: Labour union, productivity versus monetary shocks, business cycle
    JEL: E24 E32
    Date: 2010–02–10
  10. By: Jonathan Berk; Johan Walden
    Abstract: The non-tradability of human capital is often cited for the failure of traditional asset pricing theory to explain agents' portfolio holdings. In this paper we argue that the opposite might be true --- traditional models might not be able to explain agent portfolio holdings because they do not explicitly account for the fact that human capital does trade (in the form of labor contracts). We derive wages endogenously as part of a dynamic equilibrium in a production economy. Risk is shared in labor markets because firms write bilateral labor contracts that insure workers, allowing agents to achieve a Pareto optimal allocation even when the span of asset markets is restricted to just stocks and bonds. Capital markets facilitate this risk sharing because it is there that firms offload the labor market risk they assumed from workers. In effect, by investing in capital markets investors provide insurance to wage earners who then optimally choose not to participate in capital markets. The model can produce some of the most important stylized facts in asset pricing: (1) limited asset market participation, (2) the seemingly high equity risk premium, (3) the very large disparity in the volatility of consumption and the volatility of asset prices, and (4) the time dependent correlation between consumption growth and asset returns.
    JEL: G11 G12 J24
    Date: 2010–01
  11. By: Hea-Jung Hyun (Korea Institute for International Economic Policy)
    Abstract: Using firm-level data on offshoring of Korean manufacturers, the paper examines the relationship between firm heterogeneity and the probability of adopting offshoring. The results of the paper suggest that firm productivity may not be an important determinant for Korean firms’ offshoring decision. Firm’s global sourcing decision may rather depend on other characteristics such as factor intensity, R&D intensity, ICT level, and affiliation with foreign markets, when industry specificity is controlled for.
    Keywords: Offshoring, Outsourcing, Insourcing, Firm Heterogeneity.
    JEL: F23 L23 D21
    Date: 2009
  12. By: Xin Xu; Robert Kaestner
    Abstract: In this paper, we take a structural approach to investigate the effects of wages and working hours on health behaviors of low-educated persons using variation in wages and hours caused by changes in economic activity. We find that increases in hours are associated with an increase in cigarette smoking, a reduction in physical activity, and fewer visits to physicians. More importantly, we find that most of the effects associated with changes in hours can be attributed to the changes in the extensive margin of employment. Increases in wages are associated with greater consumption of cigarettes.
    JEL: I12 J22
    Date: 2010–02
  13. By: Efraim Benmelech; Nittai K. Bergman
    Abstract: Do bankrupt firms impose negative externalities on their non-bankrupt competitors? We propose and analyze a collateral channel in which a firm’s bankruptcy reduces collateral values of other industry participants, thereby increasing the cost of external debt finance industry wide. To identify this collateral channel, we use a novel dataset of secured debt tranches issued by U.S. airlines which includes a detailed description of the underlying assets serving as collateral. Our estimates suggest that industry bankruptcies have a sizeable impact on the cost of debt financing of other industry participants. We discuss how the collateral channel may lead to contagion effects which amplify the business cycle during industry downturns.
    JEL: E32 E44 G12 G33 L93
    Date: 2010–01
  14. By: Michele Santoni (Università degli Studi di Milano)
    Abstract: This paper studies the effects of product market integration on wage-bargaining institutions. It first shows evidence of a negative correlation between the level of wage bargaining and proxy measures of integration, such as the degree of openness and import penetration, for a macro-panel of 17 OECD countries over the 1975-2000 period. It then develops a theoretical model of an import-competing unionised Cournot-Nash oligopoly. The model shows that a reduction in trade barriers, by lowering the sharable surplus between home firms and labour when the final goods are substitutes, gives unions incentives to choose more decentralised wage-bargaining institutions. This industry-level mechanism, however, works in the opposite direction with either complements or two-way trade and homogeneous goods. In these cases, cutting trade barriers raises the sharable surplus and encourages domestic wage-setters to choose more centralised institutions.
    Keywords: Endogenous wage bargaining institutions, Unionised oligopolies, Trade integration,
    Date: 2009–10–29
  15. By: Andrea Gerali (Bank of Italy); Stefano Neri (Bank of Italy); Luca Sessa (Bank of Italy); Federico M. Signoretti (Bank of Italy)
    Abstract: This paper studies the role of credit-supply factors in business cycle fluctuations. For this purpose, we introduce an imperfectly competitive banking sector into a DSGE model with financial frictions. Banks issue collateralized loans to both households and firms, obtain funding via deposits and accumulate capital from retained earnings. Margins charged on loans depend on bank capital-to-assets ratios and on the degree of interest rate stickiness. Bank balance-sheet constraints establish a link between the business cycle, which affects bank profits and thus capital, and the supply and cost of loans. The model is estimated with Bayesian techniques using data for the euro area. The analysis delivers the following results. First, the existence of a banking sector partially attenuates the effects of demand shocks, while it helps propagate supply shocks. Second, shocks originating in the banking sector explain the largest share of the fall of output in 2008 in the euro area, while macroeconomic shocks played a limited role. Third, an unexpected destruction of bank capital has a substantial impact on the real economy and particularly on investment.
    Keywords: collateral constraints, banks, banking capital, sticky interest rates
    JEL: E30 E32 E43 E51 E52
    Date: 2010–01
  16. By: Cabral, Luis (IESE Business School)
    Abstract: I consider a dynamic model of competition between two proprietary networks. Consumers die and are replaced with a constant hazard rate; and firms compete for new consumers to join their network by offering network entry prices. I derive a series of results pertaining to: a) existence and uniqueness of symmetric equilibria, b) monotonicity of the pricing function (e.g., larger networks set higher prices), c) network size dynamics (increasing dominance vs. reversion to the mean), and d) firm value (how it varies with network effects). Finally, I apply my general framework to the study of termination charges in wireless telecommunications. I consider various forms of regulation and examine their impact on firm profits and market share dynamics.
    Keywords: Networks; dynamic competition; oligopoly competition; wireless telecommunications;
    Date: 2009–12–10
  17. By: Massimiliano Affinito (Banca d'Italia); Edoardo Tagliaferri (Banca d'Italia)
    Abstract: This paper investigates the ex-ante determinants of bank loan securitization by using different econometric methods on Italian individual bank data from 2000 to 2006. Our results show that bank loan securitization is a composite decision. Banks that are less capitalized, less profitable, less liquid and burdened with troubled loans are more likely to perform securitization, for a larger amount and earlier.
    Keywords: securitization, credit risk transfer, capital requirements, liquidity needs
    JEL: G21 G28 C23 C24
    Date: 2010–01
  18. By: Efraim Benmelech; Nittai K. Bergman
    Abstract: We provide novel evidence linking the level of creditor protection provided by law to the degree of usage of technologically older, vintage capital in the airline industry. Using a panel of aircraft-level data around the world, we find that better creditor rights are associated with both aircraft of a younger vintage and newer technology as well as firms with larger aircraft fleets. We propose that by mitigating financial shortfalls, enhanced legal protection of creditors facilitates the ability of firms to make large capital investments, adapt advanced technologies and foster productivity.
    JEL: E22 E44 G32 G33 L93
    Date: 2010–02
  19. By: Debaere, Peter (University of Virginia); Görg, Holger (Kiel Institute for the World Economy); Raff, Horst (Kiel Institute for the World Economy)
    Abstract: We use unique plant-level data to study the link between the local availability of services and the decision of manufacturing firms to source materials from abroad. To guide our empirical analysis we develop a monopolistic-competition model of the materials sourcing decisions of heterogeneous firms. The model generates predictions about how the intensity of international sourcing of materials depends on a firm’s productivity and the availability of local services. These predictions are supported by the data. We find evidence that more productive manufacturing firms tend to have a higher ratio of imported materials to sales. In addition, we find evidence that services grease the wheels of international commerce: A greater availability of services across regions, industries and time increases a firm’s foreign sourcing of materials relative to sales. Interestingly, this positive impact of local service availability on imports especially applies to stand-alone firms that, unlike multinationals, are less likely to rely on imported or internally provided services.
    Keywords: international trade, services, off-shoring, supply chain management, firm heterogeneity
    JEL: F12 L23
    Date: 2010–01
  20. By: Zhou, H.; Dekker, R.; Kleinknecht, A. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: Firms with high shares of workers on fixed-term contracts have significantly higher sales of imitative new products but perform significantly worse on sales of inno¬va¬tive new products (“first on the marketâ€). High functional flexibility in “insider-outsider†la¬bor markets enhances a firm’s new product sales, as do training efforts and highly edu¬ca¬¬ted personnel. We find weak evidence that larger and older firms have higher new pro¬duct sales than do younger and smaller firms. Our findings should be food for thought to eco-nomists making unqualified pleas for the deregulation of labor markets.
    Keywords: J5;M5;O15;O31;innovation performance;new product sales;numerical flexibility;OSA longitudinal dataset;SMEs
    Date: 2010–01–21
  21. By: Fatemi, Farshad
    Abstract: We consider a Hotelling model of price competition where firms may acquire costly information regarding the preferences (i.e. “location”) of customers. By purchasing additional information, a firm has a finer partition regarding customer preferences, and its pricing decisions must be measurable with respect to this partition. If information acquisition decisions are common knowledge at the point where firms compete via prices, we show that a pure strategy subgame perfect equilibrium exists, and that there is “excess information acquisition” from the point of view of the firms. If information acquisition decisions are private information, a pure strategy equilibrium fails to exist. We compute a mixed strategy equilibrium for a range of parameter values.
    Keywords: Information Acquisition; Price Discrimination
    JEL: L13 D82 D43
    Date: 2010–01–30
  22. By: Konings, Jozef (Catholic University of Leuven); Vanormelingen, Stijn (Catholic University of Leuven)
    Abstract: This paper uses firm level panel data of firm provided training to estimate its impact on productivity and wages. To this end the strategy proposed by Ackerberg, Caves and Frazer (2006) for estimating production functions to control for the endogeneity of input factors and training is applied. The productivity premium for a trained worker is estimated at 23%, while the wage premium of training is estimated at 12%. Our results give support to recent theories that explain work related training by imperfect competition in the labor market.
    Keywords: training, production functions, human capital
    JEL: J24 J31 L22
    Date: 2010–01
  23. By: Young Gak Kim (Japan Center For Economic Research)
    Abstract: The US economy had accelerated economic growth since the late 1990s. At first, many economists and policy makers believed that the rapid growth in the IT industry and IT investment contributed to the acceleration in US economic growth and many advanced countries supported the IT industry and IT investment in their own countries. However, the gap in rates of economic or productivity growth between the US and other advanced countries has remained even in the early 2000s. Since then, many economists have paid attention to the complementary role in intangible assets in productivity growth, that is, they started to believe that without intangible assets, the IT assets does not contribute to productivity growth at the firm and aggregated level.
    Keywords: Japanese firms, Korean firms, management practices, firm performance
    JEL: D02 D21 D23 D24
    Date: 2009
  24. By: Attila Ambrus; Markus Mobius; Adam Szeidl
    Abstract: We develop a model of informal risk-sharing in social networks, where relationships between individuals can be used as social collateral to enforce insurance payments. We characterize incentive compatible risk-sharing arrangements and obtain two results. (1) The degree of informal insurance is governed by the expansiveness of the network, measured by the number of connections that groups of agents have with the rest of the community, relative to group size. Two-dimensional networks, where people have connections in multiple directions, are sufficiently expansive to allow very good risk-sharing. We show that social networks in Peruvian villages satisfy this dimensionality property; thus, our model can explain Townsend's (1994) puzzling observation that village communities often exhibit close to full insurance. (2) In second-best arrangements, agents organize in endogenous "risk-sharing islands" in the network, where shocks are shared fully within, but imperfectly across islands. As a result, network based risk-sharing is local: socially closer agents insure each other more.
    JEL: D02 D31 D70
    Date: 2010–02
  25. By: Matteo Bugamelli (Banca d'Italia); Riccardo Cristadoro (Banca d'Italia); Giordano Zevi (Banca d'Italia)
    Abstract: We study the effects of the world economic crisis which began in 2007 on the Italian productive system. National accounts data are supplemented with information gathered in spring 2009 from the Bank of Italy’s survey on industrial and service firms, and from interviews with about 70 of their managers. Our sources confirm that this recession is the most severe recorded since the Second World War and that more than in the past, the recovery of the Italian economy will have to rely on internal demand dynamics and on firms’ ability to respond to increased competitive pressure. Our rich dataset allows us to formulate some initial responses to important issues by distinguishing between firms according to size, sector and propensity to export. When the crisis struck, the Italian productive system was in the middle of a profound, albeit partial, restructuring process, the first fruits of which were beginning to be seen. It is therefore important to understand whether some of the firms that have been most involved in the restructuring process and which are therefore in debt today, are encountering external funding difficulties in this context of widespread falling demand—difficulties serious enough to threaten their very survival.
    Keywords: cyclical fluctuations, recession, investment, firms’ strategies, microdata, restructuring
    JEL: C21 E22 E23 L20
    Date: 2009–12
  26. By: Pierre Collin-Dufresne; Robert S. Goldstein; Jean Helwege
    Abstract: Empirical tests of reduced form models of default attribute a large fraction of observed credit spreads to compensation for jump-to-default risk. However, these models preclude a "contagion-risk'' channel, where the aggregate corporate bond index reacts adversely to a credit event. In this paper, we propose a tractable model for pricing corporate bonds subject to contagion-risk. We show that when investors have fragile beliefs (Hansen and Sargent (2009)), contagion premia may be sizable even if P-measure contagion across defaults is small. We find empirical support for contagion in bond returns in response to large credit events. Model calibrations suggest that while contagion risk premia may be sizable, jump-to-default risk premia have an upper bound of a few basis points.
    JEL: G12 G13
    Date: 2010–02

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