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
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
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn, nep-mon and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:ofr:wpaper:20-05
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