Using proprietary credit default swap (CDS) data, I investigate how capital shocks at protection sellers impact pricing in the CDS market. Seller capital shocks-measured as CDS portfolio margin payments-account for 12% of the time-series variation in weekly spread changes, a significant amount given that standard credit factors account for 18% during my sample. In addition, seller shocks possess information for spreads that is independent of institution-wide measures of constraints. These findings imply a high degree of market segmentation, and suggest that frictions within specialized financial institutions prevent capital from flowing into the market at shorter horizons.

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I analyze a rare disasters economy that yields a measure of the risk neutral probability of a macroeconomic disaster, p § t . A large panel of options data provides strong evidence that p § t is the single factor driving option-implied jump risk measures in the cross section of firms. This is a core assumption of the rare disasters paradigm. A number of empirical patterns further support the interpretation of p § t as the risk-neutral likelihood of a disaster. First, standard forecasting regressions reveal that increases in p § t lead to economic downturns. Second, disaster risk is priced in the cross section of U.S. equity returns. A zero-cost equity portfolio with exposure to disasters earns risk-adjusted returns of 7.6% per year. Finally, a calibrated version of the model reasonably matches the: (i) sensitivity of the aggregate stock market to changes in the likelihood of a disaster and (ii) loss rates of disaster risky stocks during the 2008 financial crisis.