Understanding the Impact of Monetary Policy Shocks on the Corporate Bond Market in Good and Bad Times: A Markov Switching Model

Massimo Guidolin, Alexei G. Orlov and Manuela Pedio ()

No 1623, BAFFI CAREFIN Working Papers from BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy

Abstract: We study the effects of a conventional monetary expansion, quantitative easing, and operation twist on corporate bond yields and spreads. These policies are simulated as shocks to the Treasury yield curve, and the impulse response functions of corporate yields and spreads to shocks are computed using flexible models with regimes. We construct weekly bond portfolios sorting individual bond trades by rating and maturity using TRACE. The paper examines two types of models—single-state vector autoregressive (VAR) models and three-state Markov switching VAR models. Our results indicate that a standard single-state VAR model is inadequate to capture the dynamics of the data. We find that none of the policies—conventional or unconventional—can persistently lower corporate spreads. This result is likely due to the negative expectations about the business cycle generated by these policies, which affect bond risk premia. Operation twist is the only policy capable of lowering corporate yields. This finding can be explained by the fact that operation twist, which does not imply an expansion of the monetary base, is able to flatten the riskless yield curve without generating expectations of higher future inflation.

Keywords: Unconventional monetary policy; corporate bonds; term structure of Treasury yields; vector autoregression; Markov switching (search for similar items in EconPapers)
JEL-codes: C32 E43 G12 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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