Research and Studies

Home > Research and Studies > Bank of Japan Working Paper Series, Review Series, and Research Laboratory Series > Bank of Japan Working Paper Series 2000 > Predicting the US Real GDP Growth Using Yield Spreads of Corporate Bonds

Predicting the US Real GDP Growth Using Yield Spreads of Corporate Bonds

July 2000
Yoshihito SAITO
Yoko TAKEDA

Papers in the International Department Working Paper Series are circulated in order to stimulate discussion and comments. Views expressed are those of authors and do not necessarily reflect those of Bank of Japan or the International Department.
If you have any comment or question on the working paper series, please contact each author whose e-mail address is shown in the columns next to each title.

Click on iwp00e03.pdf (201KB) to download the full text.

Summary

  1. In general, the yield spread between long- and short-term bonds contains useful information for future economic activity and inflation. Particularly, it usually reflects market participants' expectations of future monetary policy and credit demand. However, it is becoming increasingly difficult to extract such information from the yield spread of government bonds in the US because of the impact of the so-called "flight to quality" where investors seek refuge in risk-free government bonds during a financial crisis, and also because of a reduction in the new issue of such bonds.
  2. This paper examines the power of the yield spread of corporate bonds as a substitute for government bonds in predicting economic activity. From empirical studies, we find that the yield spread of corporate bonds is a more effective predictor than government bonds for economic activity.
  3. Since the mid-1990s, the US fiscal balance has rapidly improved. As a result, the risk premium stemming from accumulating public debt has decreased, leading to the structural narrowing of the yield spread. After excluding the impact of the improved fiscal situation, we find that the yield spreads of both corporate and government bonds provide more useful information for future economic activity.
  4. Considering the relatively stable credit risk premium observed in corporate bond yields, more attention should be paid to the information contained in the yield spread of corporate bonds for future economic activity. Our estimation indicate that the current level of yield spread of corporate bonds predicts the strong continuous expansion of the U.S. economy extending into the near future.

Key terms:
Yield Spread, Predictive Power, Government Bonds, Corporate Bonds

JEL classification:
E44, E47, G14