The Effect of Monetary Policy on Firms' Credit Risk Premia

Abstract

The European Central Bank (ECB) has been implementing conventional and non-conventional monetary policies to lower systemic risk factors, especially since the Euro-Debt crisis of 2010-2012. However, how effective were these policies in easing financial conditions and reducing the risk premia of European non-financial firms (NFCs)? This paper examines the effect of the ECB's policies on NFCs' credit default swaps (CDSs). We collected daily CDS prices of publicly traded European NFCs to analyze the immediate short-term effects of the policy announcements between June 2nd, 2014, and December 30th, 2016. We also test the possible impact of the various policies on NFCs' CDS prices using monthly data from January 2008 to February 2018. Our primary findings are fourfold: First, the ECB's asset purchase programme announcements seem to affect CDSs on the day of the announcements and in the subsequent days. Second, these announcements had a stronger effect on CDS prices after the main public sector asset purchase programmes (PSPP) started in March 2015. Third, between 2008 and 2012 and between 2015 and 2018, after controlling for the Federal Reserve's monetary policy, the ECB's interest rate policy had statistically and economically significant effects in reducing monthly CDS prices. Fourth, some of the ECB's asset purchase programmes, such as the PSPP, had a statistically significant effect on monthly prices. These findings indicate that some of the ECB's policies have significantly cut firms' risk premiums since 2015 as market conditions improved.

Keywords: ECB monetary policy, credit default swap, quantitative easing, non-financial firms' credit risk premia. JEL Classification codes: E52, E52, E58, firms’ credit risk, credit default swap, , quantitative easing, non-financial firms, credit risk premia

JEL Classification: E52, E58