NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Credit Spreads and Business Cycle Fluctuations

Simon Gilchrist, Egon Zakrajšek

NBER Working Paper No. 17021
Issued in May 2011
NBER Program(s):   AP   EFG   ME

This paper examines the evidence on the relationship between credit spreads and economic activity. Using an extensive data set of prices of outstanding corporate bonds trading in the secondary market, we construct a credit spread index that is--compared with the standard default-risk indicators--a considerably more powerful predictor of economic activity. Using an empirical framework, we decompose our index into a predictable component that captures the available firm-specific information on expected defaults and a residual component--the excess bond premium. Our results indicate that the predictive content of credit spreads is due primarily to movements in the excess bond premium. Innovations in the excess bond premium that are orthogonal to the current state of the economy are shown to lead to significant declines in economic activity and equity prices. We also show that during the 2007-09 financial crisis, a deterioration in the creditworthiness of broker-dealers--key financial intermediaries in the corporate cash market--led to an increase in the excess bond premium. These find- ings support the notion that a rise in the excess bond premium represents a reduction in the effective risk-bearing capacity of the financial sector and, as a result, a contraction in the supply of credit with significant adverse consequences for the macroeconomy.

download in pdf format
   (504 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w17021

Published: Simon Gilchrist & Egon Zakrajsek, 2012. "Credit Spreads and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 102(4), pages 1692-1720, June. citation courtesy of

Users who downloaded this paper also downloaded these:
Jermann and Quadrini w15338 Macroeconomic Effects of Financial Shocks
Schularick and Taylor w15512 Credit Booms Gone Bust: Monetary Policy, Leverage Cycles and Financial Crises, 1870-2008
Cúrdia and Woodford w15289 Credit Spreads and Monetary Policy
Gilchrist, Yankov, and Zakrajšek w14863 Credit Market Shocks and Economic Fluctuations: Evidence from Corporate Bond and Stock Markets
Faust, Gilchrist, Wright, and Zakrajšek w16725 Credit Spreads as Predictors of Real-Time Economic Activity: A Bayesian Model-Averaging Approach
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us