The Journal of Finance

Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure

Published: 11/09/2010   |   DOI: 10.1111/j.1540-6261.2010.01613.x

HUI CHEN

I build a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the credit spread puzzle and the under‐leverage puzzle in a unified framework. The model generates interesting dynamics for financing and defaults, including market timing in debt issuance and credit contagion. It also provides a novel procedure to estimate state‐dependent default losses.

Houses as ATMs: Mortgage Refinancing and Macroeconomic Uncertainty

Published: 10/08/2019   |   DOI: 10.1111/jofi.12842

HUI CHEN, MICHAEL MICHAUX, NIKOLAI ROUSSANOV

Mortgage refinancing activity associated with extraction of home equity contains a strongly countercyclical component consistent with household demand for liquidity. We estimate a structural model of liquidity management featuring countercyclical idiosyncratic labor income uncertainty, long‐ and short‐term mortgages, and realistic borrowing constraints. We empirically evaluate its predictions for households' choices of leverage, liquid assets, and mortgage refinancing using microlevel data. Taking the observed historical paths of house prices, aggregate income, and interest rates as given, the model accounts for many salient features in the evolution of balance sheets and consumption in the cross‐section of households over 2001 to 2012.

A Unified Theory of Tobin's q, Corporate Investment, Financing, and Risk Management

Published: 09/21/2011   |   DOI: 10.1111/j.1540-6261.2011.01681.x

PATRICK BOLTON, HUI CHEN, NENG WANG

We propose a model of dynamic investment, financing, and risk management for financially constrained firms. The model highlights the central importance of the endogenous marginal value of liquidity (cash and credit line) for corporate decisions. Our three main results are: (1) investment depends on the ratio of marginal q to the marginal value of liquidity, and the relation between investment and marginal q changes with the marginal source of funding; (2) optimal external financing and payout are characterized by an endogenous double‐barrier policy for the firm's cash‐capital ratio; and (3) liquidity management and derivatives hedging are complementary risk management tools.

Measuring “Dark Matter” in Asset Pricing Models

Published: 03/03/2024   |   DOI: 10.1111/jofi.13317

HUI CHEN, WINSTON WEI DOU, LEONID KOGAN

We formalize the concept of “dark matter” in asset pricing models by quantifying the additional informativeness of cross‐equation restrictions about fundamental dynamics. The dark‐matter measure captures the degree of fragility for models that are potentially misspecified and unstable: a large dark‐matter measure indicates that the model lacks internal refutability (weak power of optimal specification tests) and external validity (high overfitting tendency and poor out‐of‐sample fit). The measure can be computed at low cost even for complex dynamic structural models. To illustrate its applications, we provide quantitative examples applying the measure to (time‐varying) rare‐disaster risk and long‐run risk models.

The Dark Side of Circuit Breakers

Published: 02/23/2024   |   DOI: 10.1111/jofi.13310

HUI CHEN, ANTON PETUKHOV, JIANG WANG, HAO XING

Market‐wide circuit breakers are trading halts aimed at stabilizing the market during dramatic price declines. Using an intertemporal equilibrium model, we show that a circuit breaker significantly alters market dynamics and affects investor welfare. As the market approaches the circuit breaker, price volatility rises drastically, accelerating the chance of triggering the circuit breaker—the so‐called “magnet effect,” returns exhibit increasing negative skewness, and trading activity spikes up. Our empirical analysis supports the model's predictions. Circuit breakers can affect overall welfare negatively or positively, depending on the relative significance of investors' trading motives for risk sharing versus irrational speculation.

Pledgeability and Asset Prices: Evidence from the Chinese Corporate Bond Markets

Published: 07/18/2023   |   DOI: 10.1111/jofi.13266

HUI CHEN, ZHUO CHEN, ZHIGUO HE, JINYU LIU, RENGMING XIE

We provide causal evidence on the value of asset pledgeability by exploiting a unique feature of Chinese corporate bond markets: bonds with identical fundamentals are traded on two segmented markets with different rules for repo transactions. Using a policy shock that rendered AA+ and AA bonds ineligible for repo on one market only, we compare how bond prices changed across markets and rating classes around this event. When the haircut increases from 0% to 100%, bond yields increase by 39 bps to 85 bps. These estimates help us infer the magnitude of the shadow cost of capital in China.