Banks Strategies and Credit Spreads as Leading Indicators for the Real Business Cycles Fluctuations

01/11/2015 |  Barnea Emanuel, Menashe Yigal
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The Banking System

Following Gilchrist and Zakrajsek (2012), we decompose bond credit spreads into a component that reflects the probability of default of the corporate firm and a residual referred to as "excess bond premium" (henceforth EBP). The latter appears to be a leading indicator of real business cycles. Our main contribution is in providing empirical support to the hypothesis that the EBP in part reflect the influence of the commercial banks’ strategies on corporate bond pricing. This influence emanates from the superiority of information on firms' debt repayment and settlement banks have and capital market lenders do not. This superiority comes about from the relatively high monitoring costs and the constrained restructuring ability capital market lenders face. These findings are consistent with the notion that a rise in EBP reflects a measure taken by banks that could lead to further downturns in the economy.