American Economic Review: Vol. 102 No. 4 (June 2012)


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Credit Spreads and Business Cycle Fluctuations

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Gilchrist, Simon, and Egon Zakrajšek. 2012. "Credit Spreads and Business Cycle Fluctuations." American Economic Review, 102(4): 1692-1720.

DOI: 10.1257/aer.102.4.1692


Using micro-level data, we construct a credit spread index with considerable predictive power for future economic activity. We decompose the credit spread into a component that captures firm-specific information on expected defaults and a residual component—the excess bond premium. Shocks to the excess bond premium that are orthogonal to the current state of the economy lead to declines in economic activity and asset prices. An increase in the excess bond premium appears to reflect a reduction in the risk-bearing capacity of the financial sector, which induces a contraction in the supply of credit and a deterioration in macroeconomic conditions.

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Gilchrist, Simon (Boston U)
Zakrajšek, Egon (Federal Reserve Board)

JEL Classifications

E32: Business Fluctuations; Cycles
E44: Financial Markets and the Macroeconomy
G12: Asset Pricing; Trading volume; Bond Interest Rates
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms

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