Credit Risk and the Transmission of Interest Rate Shocks

Berardino Palazzo and Ram Yamarthy ()
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Ram Yamarthy: Office of Financial Research

No 20-05, Working Papers from Office of Financial Research, US Department of the Treasury

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 (search for similar items in EconPapers)
Pages: 70 pages
Date: 2020-12-03
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn, nep-mon and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Credit risk and the transmission of interest rate shocks (2022)
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