Future Economic Information Embedded in High Yield Spreads

12 Pages Posted: 16 Apr 2019 Last revised: 18 Apr 2019

See all articles by Jack Clark Francis

Jack Clark Francis

Zicklin School of Business, Baruch College

Christopher Hessel

City University of New York

Jun Wang

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Date Written: April 14, 2016

Abstract

Future Economic Information Embedded in High Yield Spreads

The financial accelerator mechanism, also called credit channel theory (Bernanke and Gertler [1995] and Bernanke and Gertler, and Gilchrist [1996]), assumes external financing is more costly than internal financing in the absence of full collateralization. The difference between external and internal costs is called “external finance premium” and arises from agency costs associated with asymmetric information about the firm’s net worth, defined as the sum of all liquid and illiquid assets minus debt. The external finance premium is inversely related to the firm’s net worth.

Firms with poor credit are at the heart of the financial accelerator mechanism, and one can proxy for “external finance premium” using the spread paid by the poor-quality (high-yield) firms over the high-quality firms. In the parlance of the “financial accelerator mechanism,” a reduction of high-yield spread is the harbinger of future boom, and an increase in high-yield spread predicts a decline in economic activity. This article examines the significance of the spread variable to predict various economic variables. We control for momentum in the economic variable by including the four lagged quarters of the economic variable. We look at the growth rate of a broad spectrum of the economy; having tested the relationship between 84 economic measures and the four lagged measures of growth in high-yield spread, we report that 58 of the economic variables tested have statistically significant coefficients.

Keywords: credit channel theory, collateral, financial accelerator mechanism

JEL Classification: G10

Suggested Citation

Francis, Jack Clark and Hessel, Christopher and Wang, Jun, Future Economic Information Embedded in High Yield Spreads (April 14, 2016). Available at SSRN: https://ssrn.com/abstract=3371916 or http://dx.doi.org/10.2139/ssrn.3371916

Jack Clark Francis (Contact Author)

Zicklin School of Business, Baruch College ( email )

One Bernard Baruch Way
New York, NY 10010
United States
646-312-3462 (Phone)

Christopher Hessel

City University of New York ( email )

17 Lexington Avenue
New York, NY 10021
United States

Jun Wang

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

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