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The predictive ability of a risk-adjusted yield spread for economic activity in Europe

Alfred Guender () and Bernard Tolan
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Bernard Tolan: New Zealand Treasury

Empirica, 2017, vol. 44, issue 1, No 1, 27 pages

Abstract: Abstract This paper examines whether the pricing of risk is important for macroeconomic activity at the country level. We design a risk-adjusted yield spread and test its predictive content for economic activity on the periphery and the centre of Europe over the 1990–2012 period. This risk-adjusted bond yield spread is defined in a cross-country context and referred to as the GZ-type spread. Increases in the yield on corporate bonds issued in the countries on the periphery relative to the riskless yield (calculated using German zero-coupon term structure data) reflect increases in the risk premium that the financial market imposes on borrowers. The risk premium rises in all countries during European-wide recessions of the recent past, particularly those associated with the Global Financial and the Sovereign Debt Crisis. Our findings indicate further that this GZ-type spread acts as a reliable signal for imminent and near-term economic activity in countries where financial markets were shaken to their foundations during the Crisis period. For Germany, the GZ-spread has predictive content for industrial production but not for the unemployment rate. For GDP its predictive ability is confined to the EMU period.

Keywords: Corporate bond yield spread; Predictive content; Economic activity in Europe; Financial and Debt Crisis (search for similar items in EconPapers)
JEL-codes: E3 E4 G1 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1007/s10663-015-9309-z

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