Credit Risk and the Transmission of Interest Rate Shocks
76 Pages Posted: 8 Mar 2021
Date Written: March 1, 2021
Using daily credit default swap (CDS) data, we find a positive relation between corporate credit risk and unexpected monetary policy shocks during FOMC announcement days. Positive shocks to interest rates increase the expected loss component of CDS spreads as well as a risk premium component. However, not all firms respond in the same manner. We show that firm-level credit risk is an important driver of the monetary policy response, both in credit and equity markets, and plays a more prominent role relative to other risk proxies. A stylized corporate model of monetary policy, investment, and financing rationalizes our findings.
Keywords: Credit risk, CDS, monetary policy, shock transmission, equity returns
JEL Classification: E52, G12, G18, G32
Suggested Citation: Suggested Citation