The Effect of Monetary Policy on Credit Spreads
58 Pages Posted: 22 Mar 2010 Last revised: 19 Feb 2014
Date Written: August 30, 2011
We analyze the effect of monetary policy on yield spreads between corporate bonds with different credit ratings over the business cycle. We use futures contracts to distinguish between expected and unexpected changes in the Fed funds target rate and several indicators to distinguish between different phases of the business cycle. In line with the predictions of imperfect capital market theories, we find that yields on corporate bonds with low credit ratings widen (narrow) with respect to those with high credit ratings following an unexpected increase (decrease) in the Fed funds target rate during recession periods. Several tests suggest that our results are robust to outliers, potential endogeneity problems, empirical specification, control variables, countercyclical risk premium in futures, and alternative definitions of credit spreads and economic conditions.
Keywords: Real-time data, Credit Channel of Monetary Policy, Fed Funds Futures, Markov Regime Switching Model, Business Cycle, Credit Cycle, Monetary Policy Cycle
JEL Classification: E4, E42, E43, E44, E5, E52, E58, G18
Suggested Citation: Suggested Citation