46 Pages Posted: 5 Jan 2011 Last revised: 28 Jun 2011
Date Written: June 28, 2011
We show that the credit quality of corporate debt issuers deteriorates during credit booms, and that this deterioration forecasts low excess returns to corporate bondholders. The key insight is that changes in the pricing of credit risk disproportionately affect the financing costs faced by low quality firms, so the debt issuance of low quality firms is particularly useful for forecasting bond returns. We show that a significant decline in issuer quality is a more reliable signal of credit market overheating than rapid aggregate credit growth. We use these findings to investigate the forces driving time-variation in expected corporate bond returns.
Keywords: credit risk, credit bubbles, forecasting regressions, debt issuance, quality
JEL Classification: G14, G32
Suggested Citation: Suggested Citation
Greenwood, Robin M. and Hanson, Samuel Gregory, Issuer Quality and the Credit Cycle (June 28, 2011). Harvard Business School Working Paper No. 1734528. Available at SSRN: https://ssrn.com/abstract=1734528 or http://dx.doi.org/10.2139/ssrn.1734528