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Ebook Credit Chains and Sectoral Comovement: Does the Use of Trade Credit Amplify Sectoral Shocks?

Submitted by wulan on Mon, 06/21/2010 - 06:12

Trade credit is an important source of short-term financing for firms in the US and around the world (Petersen and Rajan, 1997; Rajan and Zingales, 1995; Demirguc-Kunt and Maksimovic, 2001). Accounts payable are more important than bank credit for short-term financing in 60 percent of the countries covered by Worldscope, and worldwide surveys conducted by the World Bank indicate that firms typically finance about twenty percent of their working capital with trade credit. In addition to extensively using trade credit as a source of funds, most firms simultaneously grant credit to their customers (McMillan and Woodruff, 1999; Fabbri and Klapper, 2008), becoming, therefore, exposed to default risk .

These characteristics of trade credit financing have led some authors to propose it as a mechanism for the propagation and amplification of idiosyncratic shocks. The intuition is straightforward: a firm facing a default by its customers may run into liquidity problems and default on its own suppliers. This sequence of defaults propagates the shock through the supply chain and may eventually amplify it, as the chain of defaults advance and the customers of the initial defaulting firm are themselves unable to pay their accounts, starting a new round of partial defaults.

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Ebook Credit Spreads and Real Activity

Submitted by wulan on Mon, 01/18/2010 - 09:08

In this paper, I explore the transmission of credit conditions into the real economy. Indeed, disturbances in the financial sector, if allowed to develop fully, could have severe negative consequences for real activity. An implication of this link between credit markets and the economy is that credit spreads i.e., the difference between corporate and Treasury yields should forecast real activity. Establishing the presence of this link though is difficult because credit spreads in turn reflect current and lagged macroeconomic information that can potentially capture predictable components in future real activity.

I use a no arbitrage term structure model that captures the joint dynamics of GDP, inflation, Treasury yields and credit spreads to identify what drives the relationship between credit spreads and the real economy. I show that there is a component of credit spreads orthogonal to macroeconomic information that indeed forecasts future real activity, lending support to the presence of a transmission channel from borrowing conditions to the economy.

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Ebook Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads

Submitted by wulan on Sat, 09/05/2009 - 03:00

The period since August 2007 has been marked by an unusual widening of risk spreads and increased volatility in financial asset prices. One example is the spread between term interbank borrowing rates and overnight indexed swap (OIS) rates of comparable maturity. These spreads have risen from 4 basis points to more than 150 basis points at their one and three month maturities, reaching their widest levels since the inception of the OIS market. Spreads between different euro-area government bond yields have also widened dramatically over this period. For instance, the spread of the Italian ten-year government bond yield over its German counterpart rose from 20 basis points before August 2007 to over 160 basis points, reaching its highest level since the inception of the euro.

The rise in spreads could represent heightened perceived default risk or greater compensation demanded by risk averse investors against the risk of default. Alternatively, it could represent a premium demanded by investors to induce them to hold comparatively illiquid assets. Decomposing interest rate spreads into default risk and liquidity components is important for investors’ portfolio allocation decisions investors with the longest investment horizons should prefer to hold higher yielding assets if these elevated yields represent compensation for poor liquidity, but not if they represent a greater risk of default. Amihud and Mendelson (1986) and Long staff (2005) both propose models with different types of investors, in which the longer-horizon investors hold less liquid assets and receive a premium for doing so. The default versus liquidity decomposition is also important for policymakers if rising spreads primarily represent the effects of poor liquidity, then policy actions to improve market functioning could help to dampen spread widening. For example, an exchange of more liquid bonds for their less liquid counterparts could promote more orderly market functioning. On the other hand, if the widening largely represents a heightened risk of default, then only actions aiming to improve the solvency of the banks/governments in question will ultimately work.

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