Economic policy uncertainty and volatility of corporate bond credit spread: Evidence from China and the United States

Abstract

In the prevailing situation of economic instability, it is customary for governments to enact economic policies aimed at influencing the decision-making processes of corporations. Nevertheless, the uncertainty surrounding economic policies inevitably impacts the capital structure of firms, consequently giving rise to fluctuations in corporate bond credit spreads through various transmission channels. Therefore, this study examines the impact of economic policy uncertainty (EPU) on the volatility of corporate bond credit spread in China and the United States (U.S.) from January 2014 to July 2021. Developing a one-sided filtering single-factor and multi-factor GARCH-MIDAS model in which monthly EPU and daily corporate bond credit spread are used as variables with different frequencies, the total volatility of corporate bond credit spread is decomposed into long- and short-term volatility components. Utilising the EPU data, encompassing indices delineating EPU in the U.S. (Baker et al., 2016) and China (Huang and Luk, 2020), alongside the corporate bond credit spreads in both the Chinese and American markets, we find that the level and volatility of EPU positively impact the long-term volatility of corporate bond credit spread with different ratings. Moreover, the EPU level contributes to more than 12% to the total volatility of corporate bond credit spread in the Chinese samples and more than 4.31% in the U.S. samples. While the variance of EPU contributes to over 5.19% to the total volatility of corporate bond credit spread in the U.S. samples, which is more than that of the Chinese samples.