Firms’ risk and monetary transmission: revisiting the excess bond premium

Mar Domenech Palacios

No 3118, Working Paper Series from European Central Bank

Abstract: This paper examines whether firm-specific cyclical and idiosyncratic risk profiles influence corporate bond spreads and the transmission of monetary policy. I extend the standard excess bond premium (EBP) framework of Gilchrist & Zakrajšek (2012) to allow investors’ required compensation for default risk to vary with firm-level risks. Incorporating these effects reveals that a significantly larger share of a monetary policy shock’s impact on credit spreads is driven by changes in default risk compensation (as opposed to the EBP). In particular, for firms with more cyclical risk, up to one-fourth of the additional spread widening following a contractionary monetary policy shock reflects higher expected default compensation, substantially more than implied by the traditional EBP. By contrast, firms with high idiosyncratic risk show no strong differential response to monetary policy shocks relative to other firms. JEL Classification: D22, E43, E44, E52, G12

Keywords: cyclicality; excess bond premium; monetary policy; risk; sentiment (search for similar items in EconPapers)
Date: 2025-09
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20253118

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