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Credit market shocks: evidence from corporate spreads and defaults

Meeks, R (2009) Credit market shocks: evidence from corporate spreads and defaults. UNSPECIFIED. Federal Reserve Bank of Dallas Working Papers.

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Abstract

Several recent papers have found that exogenous shocks to spreads paid in corporate credit markets are a substantial source of macroeconomic fluctuations. An alternative explanation of the data is that spreads respond endogenously to expectations of future default. We use a simple model of bond spreads to derive sign restrictions on the impulse-response functions of a VAR that identify credit shocks in the bond market, and compare them to results from a benchmark recursive VAR. We find that credit market shocks cause a persistent decline in output, prices and policy rates. Historical decompositions clearly show the negative effect of adverse credit market shocks on output in the recent recession. The identified credit shocks are unrelated to exogenous innovations to monetary policy and measures of bond market liquidity, but are related to measures of risk compensation. In contrast to results found using the benchmark restrictions, our identified credit shocks account for relatively little of the variance of output. Our results are consistent with a role for shocks in financial crises, but also with a lesser but non-zero role in normal business fluctuations.

Item Type: Monograph (UNSPECIFIED)
Uncontrolled Keywords: Bond market; Vector autoregression; Business cycles; Interest rates; Financial markets
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Jim Jamieson
Date Deposited: 07 Jan 2013 18:55
Last Modified: 17 Aug 2017 18:04
URI: http://repository.essex.ac.uk/id/eprint/5003

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