Working Paper: NBER ID: w17197
Authors: Robin Greenwood; Samuel G. Hanson
Abstract: We show that the credit quality of corporate debt issuers deteriorates during credit booms, and that this deterioration forecasts low excess returns to corporate bondholders. The key insight is that changes in the pricing of credit risk disproportionately affect the financing costs faced by low quality firms, so the debt issuance of low quality firms is particularly useful for forecasting bond returns. We show that a significant decline in issuer quality is a more reliable signal of credit market overheating than rapid aggregate credit growth. We use these findings to investigate the forces driving time-variation in expected corporate bond returns.
Keywords: credit quality; corporate bonds; credit cycle; issuer quality; excess returns
JEL Codes: E32; E51; G12; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| issuer quality (L15) | excess corporate bond returns (G12) |
| decline in issuer quality (G33) | low excess returns to corporate bondholders (G33) |
| poor issuer quality (L15) | underperformance of corporate bonds relative to treasury bonds (G12) |
| low-quality firms issue more debt during credit booms (G32) | deterioration in issuer quality (L15) |
| issuer quality (L15) | predictability of returns (G17) |
| issuer quality has incremental forecasting power (L15) | future bond performance (G12) |