Inflation Risk in Corporate Bonds
72 Pages Posted: 15 Mar 2012 Last revised: 15 Jun 2018
Date Written: September 26, 2013
We argue that corporate bond yields reflect fears of debt deflation. When debt is nominal, unexpectedly low inflation increases real liabilities and default risk. In a real business cycle model with optimal but infrequent capital structure choice, more uncertain or pro-cyclical inflation leads to quantitatively important increases in corporate log yields in excess of default-free log yields. A panel of credit spread indexes from six developed countries shows that credit spreads rise by 14 basis points if inflation volatility or the inflation-stock correlation increases by one standard deviation.
Keywords: Inflation Volatility, Nominal-Real Correlation, International Credit Spreads, Corporate Default, Capital Structure, Leverage
JEL Classification: G12
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