Credit Spreads and the Severity of Financial Crises
AbstractWe study the behavior of credit spreads and their link to economic growth during
financial crises. We find that the recessions that accompany financial crises are severe
and protracted. The severity of the crisis can be forecast by the size of credit losses
(change in spreads) coupled with the fragility of the financial sector (as measured by
pre-crisis credit growth). We also find that spreads fall in the runup too a crisis and
are abormally low, even as credit grows ahead of a crisis. That is, a crisis involves a
dramatic shift in expectations and is a surprise.