IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Credit Spreads and Business Cycle Fluctuations

  • Simon Gilchrist
  • Egon Zakrajšek

This paper examines the evidence on the relationship between credit spreads and economic activity. Using an extensive data set of prices of outstanding corporate bonds trading in the secondary market, we construct a credit spread index that is--compared with the standard default-risk indicators--a considerably more powerful predictor of economic activity. Using an empirical framework, we decompose our index into a predictable component that captures the available firm-specific information on expected defaults and a residual component--the excess bond premium. Our results indicate that the predictive content of credit spreads is due primarily to movements in the excess bond premium. Innovations in the excess bond premium that are orthogonal to the current state of the economy are shown to lead to significant declines in economic activity and equity prices. We also show that during the 2007-09 financial crisis, a deterioration in the creditworthiness of broker-dealers--key financial intermediaries in the corporate cash market--led to an increase in the excess bond premium. These find- ings support the notion that a rise in the excess bond premium represents a reduction in the effective risk-bearing capacity of the financial sector and, as a result, a contraction in the supply of credit with significant adverse consequences for the macroeconomy.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.nber.org/papers/w17021.pdf
Download Restriction: no

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17021.

as
in new window

Length:
Date of creation: May 2011
Date of revision:
Publication status: published as Simon Gilchrist & Egon Zakrajsek, 2012. "Credit Spreads and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 102(4), pages 1692-1720, June.
Handle: RePEc:nbr:nberwo:17021
Note: AP EFG ME
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Web page: http://www.nber.org
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Gregory R. Duffee, 1998. "The Relation Between Treasury Yields and Corporate Bond Yield Spreads," Journal of Finance, American Finance Association, vol. 53(6), pages 2225-2241, December.
  2. Houweling, Patrick & Mentink, Albert & Vorst, Ton, 2005. "Comparing possible proxies of corporate bond liquidity," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1331-1358, June.
  3. Schaefer, Stephen M. & Strebulaev, Ilya A., 2008. "Structural models of credit risk are useful: Evidence from hedge ratios on corporate bonds," Journal of Financial Economics, Elsevier, vol. 90(1), pages 1-19, October.
  4. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  5. Jon Faust & Simon Gilchrist & Jonathan H. Wright & Egon Zakrajšsek, 2013. "Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach," The Review of Economics and Statistics, MIT Press, vol. 95(5), pages 1501-1519, December.
  6. Gary Gorton, 2009. "Information, Liquidity, and the (Ongoing) Panic of 2007," American Economic Review, American Economic Association, vol. 99(2), pages 567-72, May.
  7. Thomas Philippon, 2009. "The Bond Market's q," The Quarterly Journal of Economics, MIT Press, vol. 124(3), pages 1011-1056, August.
  8. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-76, June.
  9. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  10. Simon Gilchrist & Vladimir Yankov & Egon Zakrajsek, 2009. "Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets," NBER Working Papers 14863, National Bureau of Economic Research, Inc.
  11. James H. Stock & Mark W.Watson, 2003. "Forecasting Output and Inflation: The Role of Asset Prices," Journal of Economic Literature, American Economic Association, vol. 41(3), pages 788-829, September.
  12. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-65, September.
  13. Harvey, Campbell R., 1988. "The real term structure and consumption growth," Journal of Financial Economics, Elsevier, vol. 22(2), pages 305-333, December.
  14. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, 04.
  15. Sreedhar T. Bharath & Tyler Shumway, 2008. "Forecasting Default with the Merton Distance to Default Model," Review of Financial Studies, Society for Financial Studies, vol. 21(3), pages 1339-1369, May.
Full references (including those not matched with items on IDEAS)

This item is featured on the following reading lists or Wikipedia pages:

  1. Credit Spreads and Business Cycle Fluctuations (AER 2012) in ReplicationWiki

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:17021. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.