DP14570 The Maturity Premium
This paper shows that firms with longer debt maturities earn risk premia not explained
by unconditional standard factor models. We develop a dynamic capital structure
model and find that firms with long-term debt exhibit more countercyclical leverage,
making them more highly levered in downturns, when the market price of risk is high.
The induced covariance between risk exposure and the market price of risk generates
a maturity premium which we estimate at 0.21% per month. Empirical results from a
conditional CAPM as well as observed beta dynamics are consistent with the model.
We also exploit exogenous variation of debt maturities at the onset of the financial
crisis and find that firms with shorter debt maturities experienced a smaller increase in
leverage during the crisis. Also, after an initial spike, the betas of short-maturity firms
reverted to levels below those of long-maturity firms by the end of 2008.
