The Effect of Monetary Policy on Credit Spreads

58 Pages Posted: 22 Mar 2010 Last revised: 19 Feb 2014

See all articles by Tolga Cenesizoglu

Tolga Cenesizoglu

HEC Montreal - Department of Finance

Badye Essid

HEC Montreal - Institute of Applied Economics

Date Written: August 30, 2011

Abstract

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

Cenesizoglu, Tolga and Essid, Badye, The Effect of Monetary Policy on Credit Spreads (August 30, 2011). Journal of Financial Research, Vol. 35, No. 4, 2012. Available at SSRN: https://ssrn.com/abstract=1573264 or http://dx.doi.org/10.2139/ssrn.1573264

Tolga Cenesizoglu (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

HOME PAGE: http://www.hec.ca/en/profs/tolga.cenesizoglu.html

Badye Essid

HEC Montreal - Institute of Applied Economics

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

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