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Firms’ risk and monetary transmission: revisiting the excess bond premium

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  • Domenech Palacios, Mar

Abstract

This paper examines whether firm-specific cyclical and idiosyncratic risk profiles influence corporate bond spreads and the transmission of monetary policy. I extend the standard excess bond premium (EBP) framework of Gilchrist & Zakrajšek (2012) to allow investors’ required compensation for default risk to vary with firm-level risks. Incorporating these effects reveals that a significantly larger share of a monetary policy shock’s impact on credit spreads is driven by changes in default risk compensation (as opposed to the EBP). In particular, for firms with more cyclical risk, up to one-fourth of the additional spread widening following a contractionary monetary policy shock reflects higher expected default compensation, substantially more than implied by the traditional EBP. By contrast, firms with high idiosyncratic risk show no strong differential response to monetary policy shocks relative to other firms. JEL Classification: D22, E43, E44, E52, G12

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  • Domenech Palacios, Mar, 2025. "Firms’ risk and monetary transmission: revisiting the excess bond premium," Working Paper Series 3118, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:20253118
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    Keywords

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    JEL classification:

    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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