Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets

Abstract

To identify disruptions in credit markets, research on the role of asset prices in economic fluctuations has focused on the information content of various corporate credit spreads. We re-examine this evidence using a broad array of credit spreads constructed directly from the secondary bond prices on outstanding senior unsecured debt issued by a large panel of nonfinancial firms. An advantage of our "ground-up'' approach is that we are able to construct matched portfolios of equity returns, which allows us to examine the information content of bond spreads that is orthogonal to the information contained in stock prices of the same set of firms, as well as in macroeconomic variables measuring economic activity, inflation, interest rates, and other financial indicators. Our portfolio-based bond spreads contain substantial predictive power for economic activity and outperform-especially at longer horizons-standard default-risk indicators. Much of the predictive power of bond spreads for economic activity is embedded in securities issued by intermediate-risk rather than high-risk firms. According to impulse responses from a structural factor-augmented vector autoregression, unexpected increases in bond spreads cause large and persistent contractions in economic activity. Indeed, shocks emanating from the corporate bond market account for more than 30 percent of the forecast error variance in economic activity at the two-to four-year horizon. Overall, our results imply that credit market shocks have contributed significantly to U.S. economic fluctuations during the 1990-2008 period.

Credit Risk in the Euro Area

“…In summary, there is little evidence to suggest that euro area credit spreads are robust predictors of euro area inflation, a result that is also consistent with previous findings for the US as discussed in Gilchrist et al . ().…”

“…The estimation and identification procedure directly follows the methodology of Gilchrist et al . (). This approach relies on identifying credit supply shocks as movements in credit spreads that are contemporaneously orthogonal to information in current real activity variables as well as a rich array of asset prices.…”

The High Sensitivity of Economic Activity to Financial Frictions

“…Gilchrist et al. (2009) present extensive evidence about the forecasting power of credit spreads, along with many cites to the earlier literature.…”

Interaction of Labour and Credit Market in Growth Regimes: A Theoretical and Empirical Analysis

“…Others, for example Gilchrist et al . (), have merely added a persistent shock to the leverage ratio to obtain a higher bond yields and thus credit spreads.…”