One Risk, Two Debts: The Effects of Rare Disasters on Credit Markets

The COVID-19 pandemic has highlighted the impacts that rare disasters can have on credit markets. We discuss and quantify the asset-pricing implications of disaster risk on the risk-free rate, credit spreads, and their term structures. The findings underscore the heterogeneous effects of disasters on the risk-free and risky debt segments of credit markets. The results reveal that federal and private debt are ``two sides of the same coin”, call for a closer coordination between these two distinct sectors of the credit market, and shed light on deleveraging issues that likely lie ahead in the post-disaster world.