Description:

Joe Kaboski (Notre Dame): Information Spreads (with Jasmin Xiao and Antonio Falato)

Abstract: We propose a financially-driven business cycle propagation mechanism in which firm credit spreads arise from default concerns under incomplete information. Investors learn from public information and adjust expectations about firm creditworthiness downward in response to a deterioration in the profit outlook or increase in uncertainty. Empirically, we show that spreads and real outcomes -- both at the aggregate and firm-level -- respond predictably to the new information summarized in professional forecast revisions. Quantitatively, the model explains the high level and variation of credit spreads and the patterns in responding to public information, and establishes a novel amplification mechanism whereby credit spreads transmit changes in public information and its uncertainty to investment and the real economy.