| By: |
Berardino Palazzo (Board of Governors of the Federal Reserve System);
Ram Yamarthy (Office of Financial Research) |
| Abstract: |
Using daily credit default swap (CDS) data going back to the early 2000s, we
find a positive and significant relation between corporate credit risk and
unexpected interest rate shocks around FOMC announcement days. Positive
interest rate movements increase the expected loss component of CDS spreads as
well as a risk premium component that captures compensation for default risk.
Not all firms respond in the same manner. Consistent with recent evidence, we
find that firm-level credit risk (as proxied by the CDS spread) is an
important driver of the response to monetary policy shocks - both in credit
and equity markets - and plays a more prominent role in determining monetary
policy sensitivity than other common proxies of firm-level risk such as
leverage and market size. A stylized corporate model of monetary policy, firm
investment, and financing decisions rationalizes our findings. |
| Keywords: |
credit risk, CDS, monetary policy, shock transmission, equity returns |
| Date: |
2020–12–03 |
| URL: |
http://d.repec.org/n?u=RePEc:ofr:wpaper:20-05&r=all |