Working Paper: NBER ID: w19337
Authors: Simon Gilchrist; Egon Zakrajsek
Abstract: Estimating the effect of Federal Reserve's announcements of Large-Scale Asset Purchase (LSAP) programs on corporate credit risk is complicated by the simultaneity of policy decisions and movements in prices of risky financial assets, as well as by the fact that both interest rates of assets targeted by the programs and indicators of credit risk reacted to other common shocks during the recent financial crisis. This paper employs a heteroskedasticity-based approach to estimate the structural coefficient measuring the sensitivity of market-based indicators of corporate credit risk to declines in the benchmark market interest rates prompted by the LSAP announcements. The results indicate that the LSAP announcements led to a significant reduction in the cost of insuring against default risk--as measured by the CDX indexes--for both investment- and speculative-grade corporate credits. While the unconventional policy measures employed by the Federal Reserve to stimulate the economy have substantially lowered the overall level of credit risk in the economy, the LSAP announcements appear to have had no measurable effect on credit risk in the financial intermediary sector.
Keywords: Federal Reserve; Large-Scale Asset Purchases; Corporate Credit Risk
JEL Codes: E44; E58; G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| LSAP announcements (E60) | reduction in the cost of insuring against default risk (G32) |
| LSAP announcements (E60) | decrease in corporate credit risk (G32) |
| LSAP announcements (E60) | no measurable effect on credit risk in the financial intermediary sector (G21) |
| LSAP announcements (E60) | lower overall level of credit risk in the economy (G21) |
| financial sector's credit risk (G21) | unchanged due to LSAP measures (E39) |