Finance seminar - Professor Harjoat Bhamra - Imperial College London

A seminar by Professor Harjoat Bhamra from Imperial College London

Title: Leverage Dynamics and Learning about Economic Crises*

Abstract: Why do equity risk premia, credit spreads, and leverage remain elevated throughout crises, even though belief uncertainty, a key driver of risk premia, has faded away? Once we model firms’ balance sheets, a leverage-learning amplification mechanism turns the level of crisis-risk beliefs into a driver of risk premia. In a consumption-based Epstein-Zin model, firms choose default and leverage with learning about the stochastic intensity of downward jumps in fundamentals. As beliefs shift towards the high-intensity state, the default boundary rises, depressing equity values and raising leverage, which sustains elevated premia and credit spreads throughout a crisis.

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