Crossing the Credit Channel: Credit Spreads and Firm Heterogeneity

Abstract

We show that credit spreads rise after a monetary policy tightening, yet spread reactions are heterogeneous across firms. Exploiting information from a unique panel of corporate bonds matched with balance sheet data for US non-financial firms, we document that firms with high leverage experience a more pronounced increase in credit spreads than firms with low leverage. A large fraction of this increase is due to a component of credit spreads that is in excess of firms' expected default-the excess bond premium. Consistent with the spreads response, we also document that high-leverage firms experience a sharper contraction in debt and investment than low-leverage firms. Our results provide evidence that balance sheet effects are crucial for understanding the transmission mechanism of monetary policy.

Credit Risk and the Transmission of Interest Rate Shocks

“…For Target, Path, and BRW, we find that a 1σ monetary policy surprise generates a significant and positive increase in CDS spreads between 0.93 and 1.20 bps. This result is consistent with the results in Anderson and Cesa-Bianchi (2020), who find a positive and significant relation between weekly changes in credit spreads and monetary policy surprises. Our results are statistically significant with t-statistics between 1.81 and 3.36.…”

“…In the Appendix, we also show that the immediate effects of monetary policy shocks are mitigated when we examine a longer horizon of CDS changes. This result is in contrast to the positive and significant effect of monetary policy shocks on longer-horizon changes in credit spreads documented in Anderson and Cesa-Bianchi (2020). A part of our interpretation is that the differential result (relative to the credit spread data) is likely driven by the superior ability of the CDS market to reflect new information.…”

“…Furthermore, recent studies have shown that leverage is an important determinant of firmlevel responses to monetary policy shocks. Anderson and Cesa-Bianchi (2020) show that the response of credit spreads to monetary policy shocks is stronger for highly levered firms. Ottonello and Winberry (2019) find that firm-level investment is less responsive to monetary policy shock for firms with higher leverage.…”

“…Additionally, of course, we examine the heterogeneous impact of unexpected interest rate shocks on credit risk movements and their risk premium components. 5 In a closely related paper, Anderson and Cesa-Bianchi (2020) use secondary market prices of corporate bonds and related credit spreads as their key response variable of interest. They find that interest rate shocks indeed affect bond-based credit spreads and that more-leveraged firms are more affected.…”

“…We additionally find that unexpected movements of inter-1 A number of studies have focused on understanding the bank lending channel of monetary policy, liquidity transformation, and its connection to asset prices (see e.g., Drechsler, Savov, and Schnabl (2017) and Drechsler, Savov, and Schnabl (2018)). Another very recent working paper examines credit costs and monetary policy (Anderson and Cesa-Bianchi (2020)).…”