Credit risk and the transmission of interest rate shocks

  • How does rising interest rates affect credit risk?

    Rising rates are a risk for banks, even though many benefit by collecting higher interest rates from borrowers while keeping deposit rates low.
    Loan losses may also increase as both consumers and businesses now face higher borrowing costs—especially if they lose jobs or business revenues..

  • What is credit risk interest rate risk?

    Bonds with a heavy interest rate risk are subject to changes in interest rates, and they tend to do poorly when rates begin to rise. "Credit risk" refers to the chance that investors won't be repaid for the amount they paid in, or at least for a portion of interest and principal..

  • What is interest rate shock?

    An interest rate shock occurs when interest rates suddenly change..

  • What is the credit spread interest rate risk?

    Credit spreads are the difference between yields of various debt instruments.
    The lower the default risk, the lower the required interest rate; higher default risks come with higher interest rates.
    The opportunity cost of accepting lower default risk, therefore, is higher interest income..

  • What is the relationship between credit risk and interest rates?

    Bonds with a heavy interest rate risk are subject to changes in interest rates, and they tend to do poorly when rates begin to rise. "Credit risk" refers to the chance that investors won't be repaid for the amount they paid in, or at least for a portion of interest and principal..

  • What is the relationship between interest rates and credit risk?

    High inflation, increasing interest rates and a lagging economy can increase a company's risk for defaulting on payments or facing bankruptcy..

  • In the short-run, an increase in Treasury rates causes credit spreads to narrow.
    This effect is reversed over the long-run and higher rates cause spreads to widen.
  • While interest rates don't directly impact your credit score, there is the potential for an indirect effect on your score as rates rise.
    Higher interest rates mean you'll be paying more in interest accrual which can lead to growing debt if you're unable to pay down the principal and interest in full each month.
Abstract. Using daily credit default swap (CDS) data, we find a positive relation between corporate credit risk and unexpected monetary policy shocks during FOMC announcement days. Positive shocks to interest rates increase the expected loss component of CDS spreads as well as a risk premium component.
Using daily credit default swap (CDS) data, we find a positive relation between corporate credit risk and unexpected monetary policy shocks during FOMC announcement days. Positive shocks to interest rates increase the expected loss component of CDS spreads as well as a risk premium component.

Are firms more sensitive to interest rate shocks?

Central to our results is an intermediary pricing kernel for which larger prices of risk related to interest rate shocks correspond to larger responses of credit spreads and real quantities.
We show in the model economy that firms with higher ex-ante spreads, that are closer to default, are those that are more sensitive to interest rate shocks.

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Do interest rate shocks affect credit spreads?

Credit spreads can be decomposed into two components – an expected loss portion (compensation for losses in default) and a residual risk premium component (compensation for covariation between state prices and losses in default).
A major part of our study examines whether interest rate shocks affect these components in different ways.

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Do positive shocks to interest rates affect CDS spreads?

Positive shocks to interest rates increase the expected loss component of CDS spreads as well as a risk premium component.
However, not all firms respond in the same manner.

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Why is it important to understand the transmission of interest rate shocks?

Understanding the transmission of interest rate shocks to corporations is of paramount importance to policymakers and economic researchers, as corporate borrowing is widely used to fund investment, production, labor, and other real activities.


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