Working Paper: NBER ID: w27168
Authors: Valentin Haddad; Alan Moreira; Tyler Muir
Abstract: We study disruptions in debt markets during the COVID-19 crisis. The safer end of the credit spectrum experienced significant losses that are hard to fully reconcile with standard default or risk premium channels. Corporate bonds traded at a large discount to their corresponding CDS, and this basis widened most for safer bonds. Liquid bond ETFs traded at a large discount to their NAV, more so for Treasuries, municipal bonds, and investment-grade corporate than high-yield corporate. These facts suggest investors tried to sell safer, more liquid securities to raise cash. These disruptions disappeared nearly as fast as they appeared. We trace this recovery back to the unprecedented actions the Fed took to purchase corporate bonds rather than its interventions in extending credit. The March 23rd announcement to buy investment-grade debt boosted prices and lowered bond spreads (particularly at shorter maturities and the safer end of investment-grade) while having virtually no effect on high-yield debt. April 9th, in contrast, had a large effect on both investment-grade and high-yield, even for the riskier end of high yield which would only indirectly benefit from the policy. These facts highlight the importance of financial frictions early on in the crisis, but also challenge existing theories of these frictions.
Keywords: COVID-19; debt markets; Federal Reserve; liquidity; bond prices
JEL Codes: E5; E58; G01; G12; G18; G21; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| March 23 announcement to purchase investment-grade debt (H63) | increase in bond prices (G12) |
| March 23 announcement to purchase investment-grade debt (H63) | reduction in bond spreads (G12) |
| April 9 announcement to expand bond purchases to include fallen angels (E60) | broader effects on investment-grade and high-yield bonds (G12) |
| April 9 announcement to expand bond purchases to include fallen angels (E60) | price recovery in these markets (Q02) |
| Fed interventions (G28) | decline in yields for investment-grade bonds (G12) |
| Fed interventions (E52) | decline in yields for shorter maturities (E43) |
| Fed interventions (E52) | rapid recovery of bond prices (G12) |
| Fed interventions (E52) | restoration of liquidity and stabilization of the bond market (E44) |