Working Papers

Sources of Debt and Expected Stock Return [Link]

Firms borrowing from the public bond market on average have 5.7% per annum higher subsequent stock returns than firms borrowing from banks. The return spread is larger, about 9% per annum, among less profitable and small firms. Neither q-factor model nor Fama-French 5-factor model can explain this return spread. Bonds are difficult to renegotiate in bad states due to a large number of creditors whereas bank loans are easy to renegotiate. Borrowing from the bond market makes a firm riskier than borrowing from banks all else equal. On aggregate, the percentage of the corporate bond in the total corporate debt has superior in-sample and out-of-sample performance in predicting the equity premium, which validates the interpretation of the risk associated with sources of debt.

Work in Progress

Financial Shocks and Asset Returns

I examine equity premium in a one-sector growth economy that has two aggregate uncertainties, a shock to total factor of productivity and a shock to firms’ financing cost. The financing cost is modeled to be the reduction in financial intermediary’s intermediation capability. Firms’ borrowing constraints reduce firms’ choice set when facing productivity shocks. I construct a general equilibrium model that features representative agent with Epstein-Zin preference, long-run risk in aggregate productivity, and uncertainty in aggregate financing conditions. I calibrate the model to match US post-war data. The model is able to generate sizable equity premium as well as the Sharpe ratio that is close to the data.