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The Dynamics of the Credit Spread and Monetary Policy

Empirical Evidence from the Korean Bond Market

Inwon Jang is at the Deparment of Finance, Girard School of Business, Merrimack College, Boston, US.

David Kim

David Kim is at the Economics Department, The University of Sydney, Sydney NSW 2006, Australia, e-mail: d.kim{at}econ.usyd.edu.au.

This paper empirically examines the aggregate determinants of the credit spread and the influence of monetary policy shocks on its dynamics in Korea. Using the innovations accounting technique from an estimated vector autoregression (VAR) model, we provide a set of interesting results on the short run and the medium run determinants of the credit spread and its dynamics. The key findings are that (i) the default risk premium is the major driving force of the credit spread dynamics for low grade bonds, and (ii) monetary policy is a significant driving force of the medium term dynamics of the credit spread.

Key Words: Credit spread • default risk premium • liquidity risk premium • monetary policy • vector autoregression • Korea • JEL Classification: E32 • JEL Classification: E44 • JEL Classification: E52 • JEL Classification: G12

Journal of Emerging Market Finance, Vol. 8, No. 2, 109-131 (2009)
DOI: 10.1177/097265270900800202


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