Corporate Yield Spread and Real Activity in Emerging Asia

Evidence of a Financial Accelerator for Korea

This paper investigates the relationship between corporate bond market and real economic activity. A linear model is estimated by using the Generalized Method of Moments (GMM) indicating that the yield spread of corporate bonds (AA-) relative to government bonds - a proxy of liquidity and default risk, known as external finance premium (EFP) - predicts changes in unemployment rate up to six months in the future. An impulse response analysis based on a multivariate VAR shows that a temporary increase in EFP, leads to a persistent increase in unemployment rate, notably after two to eight months. The response of unemployment rate to monetary policy shock is much lower when channel acting through the EFP is blocked off. This evidence is consistent with an operative balance sheet channel of the monetary transmission mechanism, an important result for policy makers and investors. Consequently an efficient and liquid corporate bond market, achieved through financial integration, is of essential meaning for economic growth in Korea.