Policy Uncertainty and Corporate Credit Spreads

Abstract

We find a significant positive relation between changes in policy uncertainty and changes in credit spreads. Macroeconomic conditions, including general uncertainty, do not explain this result, which also holds when we use instrumental variables to address endogeneity issues. Policy uncertainty consistently emerges as one of the most important determinants of variation in spreads. Its impact is greater for firms that are more exposed to government policies, such as those operating in regulation-intensive industries, paying high effective tax rates, and dependent on government spending. It is also stronger for firms that engage in political activities, and for those that are more dependent on external financing. We conclude that policy uncertainty has a significant effect on firms' borrowing costs, with exposure to government policies representing an important channel.