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Working Paper
Interest rate swaps and corporate default
This paper studies firms' usage of interest rate swaps to manage risk in a model economy driven by aggregate productivity shocks, inflation shocks, and counter-cyclical idiosyncratic productivity risk. Consistent with empirical evidence, firms in the model are fixed-rate payers, and swap positions are negatively correlated with the term spread. In the model, swaps affect firms' investment decisions and debt pricing very moderately, and the availability of swaps generates only small economic gains for the typical firm.
Working Paper
Country spreads and emerging countries
A number of studies have stressed the role of movements in U.S. interest rates and country spreads in driving business cycles in emerging market economies. At the same time, country spreads have been found to respond to changes in both the U.S. interest rate and domestic conditions in emerging markets. These intricate interrelationships leave open a number of fundamental questions: Do country spreads drive business cycles in emerging countries or vice versa, or both? Do U.S. interest rates affect emerging countries directly or primarily through their effect on country spreads? This paper ...
Journal Article
Analyzing the Efficacy of the Fed's Secondary Market Corporate Credit Facility
This article analyzes the effectiveness of the Secondary Market Corporate Credit Facility (SMCCF) in stabilizing the US corporate bond market during the COVID-19 pandemic. The SMCCF announcements in March and April 2020 significantly reduced credit spreads across different bond maturities, restoring a more typical upward-sloping yield curve. The Federal Reserve's bond purchases, though relatively small in scale, notably decreased credit spreads for eligible bonds compared to ineligible ones. The study's model suggests that market dynamics, including a rush to sell short-term safe bonds and ...
Journal Article
The Federal Reserve's Liquidity Backstops to the Municipal Bond Market during the COVID-19 Pandemic
The COVID-19 pandemic has caused tremendous hardship all over the world. In response, the Federal Reserve has moved quickly and aggressively to support the economy in the United States. In this article, we present some initial evidence for the effectiveness of some of the facilities in calming the municipal bond market, particularly the short-term variable-rate demand obligation (VRDO) market. We discuss the important role of liquidity backstops in mitigating runs and stabilizing financial markets in general based on insights from our study on the runs on VRDO and auction-rate securities ...
Journal Article
The Term Structure of the Excess Bond Premium: Measures and Implications
In this article, we construct daily aggregate as well as short-, medium-, and long-term "excess bond premium" (EBP) measures using a widely available corporate bond database (known as "TRACE"). The novel EBP measures we construct provide an important gauge of strains in the financial sector at different horizons. We find that the short-term EBP measure increased more dramatically at the peaks of the COVID-19 pandemic and the 2007–09 global financial crisis, but the pattern was reversed around the interest rate liftoff at the end of 2015.
Working Paper
A model of the Twin Ds: optimal default and devaluation
This paper characterizes jointly optimal default and exchange-rate policy in a small open economy with limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default occurs during contractions and is accompanied by large devaluations. The latter inflate away real wages, thereby avoiding massive unemployment. Thus, the Twin Ds phenomenon emerges endogenously as the optimal outcome. In contrast, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are shown to have ...
Working Paper
The Fed Takes On Corporate Credit Risk: An Analysis of the Efficacy of the SMCCF
We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the corporate bond market in the wake of the COVID-19 shock. The Fed announced the SMCCF on March 23 and expanded the program on April 9. Regression discontinuity estimates imply that these announcements reduced credit spreads on bonds eligible for purchase 70 basis points (bp). We refine this analysis by constructing a sample of bonds—issued by the same set of companies—that differ in their SMCCF eligibility. A diff-in-diff analysis shows that both announcements had large ...
Working Paper
The Fed Takes On Corporate Credit Risk: An Analysis of the Efficacy of the SMCCF
This paper evaluates the efficacy of the Secondary Market Corporate Credit Facility, a program designed to stabilize the U.S. corporate bond market during the COVID-19 pandemic. The program announcements on March 23 and April 9, 2020, significantly reduced investment-grade credit spreads across the maturity spectrum—irrespective of the program’s maturity-eligibility criterion—and ultimately restored the normal upward-sloping term structure of credit spreads. The Federal Reserve’s actual purchases reduced credit spreads of eligible bonds 3 basis points more than those of ineligible ...