Leverage Constraints, Macroeconomic Shocks and Credit Spreads: a General Equilibrium Approach

Abstract

I revisit a theoretical transmission mechanism from macro shocks to expected loss component of credit spreads in a calibrated DSGE model to demonstrate how aggregate shocks affect spreads. Technological and monetary policy shocks are found to be more important factors for spreads than fiscal policy shocks. I also extend the model to demonstrate that the effect of underlying macro disturbances on credit spreads is substantially amplified if the borrower faces a leverage constraint. Such a constraint also changes business cycle properties of credit-related quantities.

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