Corporate bond spreads as a proxy for external finance premium: Differentiating between bonds issued by financial institutions and bonds issued by non-financial corporations

Abstract: The objective of this paper is to study the financial accelerator mechanism by investigating the suitability of corporate bond spreads as a proxy for external finance premium. In particular, the aim is to theoretically and empirically analyze differences in predictive power over short-term real economic activity between two types of corporate bond spreads: corporate bonds issued by financial institutions and bonds issued by non-financial corporations. The topic is motivated by the ongoing debate over monetary policy measures and their effectiveness in stabilizing business cycle fluctuations and by the need for more academic research in this field. The theory of financial accelerator mechanism is first studied and an empirical investigation is then conducted on data from the euro area. The results indicate that while the spreads of corporate bonds issued by non-financial corporations possess leading indicator properties, the spreads of bonds issued by financial institutions do not contain predictive power over the short-term GDP growth. In the past research conducted on the financial accelerator, corporate bonds issued by financial institutions and those issued by non-financial corporations have not been systematically differentiated. This study suggests that a differentiation is needed since it is both theoretically grounded and supported by empirical evidence.