From Macroeconomic Shocks to Credit Spreads

Abstract

We identify the response of corporate bond credit spreads to three exogenous macroeconomic shocks: oil supply, investment-specific technology, and government spending. The response is large, significant, and close to a mirror image of the response of macroeconomic activity. The counter-cyclicality of credit spreads is mostly driven by time-varying credit risk premia, which translates into significant predictability in corporate bond returns. Standard proxies for equity risk premia exhibit similar responses, providing external validity to this argument. As causal evidence linking large, infrequent macro-shocks to credit risk premia is scarce and recent work mostly focuses on the real effects of credit market fluctuations, our findings contribute to understanding the joint dynamics of credit markets and the macroeconomy.