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Last week, the Office of Financial Research published a working paper that analyzed the relationship between unexpected movements in monetary policy and corporate credit risk as measured by credit default swaps (CDS).
The working paper, “Credit Risk and the Transmission of Interest Rate Shocks,” finds that there is a positive and significant relationship between unexpected interest rate movements around FOMC announcement days and associated credit risk movements.
More precisely, the paper finds significant heterogeneity in the sensitivities of firm-level credit risk and equity price responses to monetary policy. Firms that are ex-ante riskier, given by higher historical CDS, higher leverage, or lower market size, display greater sensitivities. Among the three, CDS seems to play the most prominent role in the transmission of monetary policy.
Finally, the study also shows that such dynamics were prominently displayed surrounding major policy actions in March 2020, in response to the financial turbulence related to the COVID pandemic.
The working paper can be found here: https://www.financialresearch.gov/working-papers/2020/12/03/credit-risk-and-the-transmission-of-interest-rate-shocks/
