Lorenzo Garlappi, Sauder School of Business

As part of the ser­ies of the "Fin­ance Re­search Sem­inar", VGSF wel­comes Lorenzo Gar­lappi from the Sauder School of Busi­ness to present his re­search pa­per.
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Pa­per

The Term Struc­ture of Credit Spreads with Dy­namic Debt Is­su­ance and In­com­plete In­form­a­tion

We in­vestig­ate credit spreads and cap­ital struc­ture dy­nam­ics in a model in which man­age­ment has private in­form­a­tion regard­ing firm value and is able to is­sue both equity and debt to ser­vice ex­ist­ing debt. Rather than choos­ing to de­fault, man­agers of in­vest­ment-­grade (IG) firms who re­ceive bad private sig­nals con­ceal this in­form­a­tion by ser­vi­cing ex­ist­ing debt via new debt is­su­ance. As such, firms with IG-­com­men­sur­ate spreads have zero jump-to-de­fault risk (and hence, com­mand zero jump-to-de­fault premium), at least until their debt ca­pa­city is fully util­ized and spreads have in­creased to “fal­len an­gel” status. These pre­dic­tions match ob­ser­va­tion well.

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