Credit Spreads and the Severity of Financial Crises

We study the behavior of credit spreads and their link to economic growth during financial crises. Our main finding is that the recessions that surround financial crises are longer and deeper than the recessions surrounding non-financial crises. The slow recovery from the 2008 crisis is in keeping with historical experience of recoveries from financial crises. We reach this conclusion by examining the relation between credit spreads and economic growth in the cross-section, across many countries and crisisevents. This cross-sectional approach differs from much of the existing literature, which instead studies the average GDP performance in countries for a set of specified crisis dates. We argue that the cross-sectional approach avoids some important shortcomings in existing studies. ∗Stanford Graduate School of Business and Yale School of Management. We thank Alan Taylor, Francis Longstaff, and seminar/conference participants at the AFA, Stanford University, and University of California Davis. We thank the International Center for Finance for help with bond data.