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The Effect of Monetary Policy on Credit Spreads

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  • Tolga Cenesizoglu
  • Badye Essid

Abstract

In this paper, we analyze the effect of monetary policy on yield spreads between corporate bonds with different credit ratings over changing conditions in the economy. Using futures data on the Fed funds rate, we distinguish between expected and unexpected changes in monetary policy. We find that unexpected changes in the Fed funds rate do not have a significant effect on changes in credit spreads when we do not control for different conditions in the economy. We then distinguish between three different cycles in the economy: business, credit and monetary policy cycles. In line with predictions of imperfect capital market theories, credit spreads widen (narrow) following an unexpected monetary policy tightening (easing) during periods of poor economic and credit market conditions. Several robustness tests suggest that our results are not due to possible endogeneity problems, lack of control variables or identification methodology or different cycles.

Suggested Citation

  • Tolga Cenesizoglu & Badye Essid, 2010. "The Effect of Monetary Policy on Credit Spreads," Cahiers de recherche 1031, CIRPEE.
    • Handle: RePEc:lvl:lacicr:1031
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    File URL: http://www.cirpee.org/fileadmin/documents/Cahiers_2010/CIRPEE10-31.pdf
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    References listed on IDEAS

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    1. Pierre Collin-Dufresn & Robert S. Goldstein & J. Spencer Martin, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
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    Cited by:

    1. Dionne, Georges & Gauthier, Geneviève & Hammami, Khemais & Maurice, Mathieu & Simonato, Jean-Guy, 2011. "A reduced form model of default spreads with Markov-switching macroeconomic factors," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 1984-2000, August.

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    More about this item

    Keywords

    Business Cycle; Moody's Bond Indices; Fed Funds Rate Futures; Monetary Policy Surprises; Credit Spreads;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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