Asymmetry in the counter-cyclicality of corporate credit spreads, across the business cycle

Abstract

This study analyzes the asymmetrical counter-cyclical behaviors of corporate credit spreads in relation to real economic fluctuations at different stages of the business cycle. Further, it explores the asymmetric counter-cyclicality of credit spreads with respect to business risk, policy uncertainty, and corporate governance-an aspect increasingly acknowledged as a central determinant of firm default risk and as a potential solution to the credit spread puzzle. Employing option adjusted spreads (OASs), which provide a more nuanced measure of credit risk, the findings demonstrate that corporate credit spreads tend to move counter-cyclically with real economic conditions, but this pattern becomes evident primarily during downturns. In a similar vein, the counter-cyclicality associated with business and policy risk factors appears to be significant solely in recessionary periods. In addition, corporate governance scores exert a counter-cyclical influence on credit spreads, with this effect intensifying during recessions relative to expansions. The presence of this asymmetrical effect indicates that corporate credit indicators are increasingly responsive to credit risk during recessions as market participants require higher risk premiums to offset heightened default risk.