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Uncertainty and the Cost of Bank vs. Bond Finance

Christian Grimme ()

MPRA Paper from University Library of Munich, Germany

Abstract: How does heightened uncertainty affect the costs of raising finance through the bond market and through bank loans? Empirically, I find that a rise in uncertainty is accompanied by an increase in corporate bond yields and a decrease in bank lending rates. This new stylized fact can be explained in a model with costly state verification and a special informational role for banks. In contrast to bond investors, banks acquire additional costly information about borrowers in times of uncertainty in order to reduce uncertainty. Having this information, the lending relationship becomes more valuable to the bank, resulting in a lower lending rate so that the relationship is not put at risk. The cost of bond finance increases because bond investors demand to be compensated for the increased risk of firm default. These findings suggest that the adverse effects of uncertainty are mitigated for firms that rely on bank finance as long as banks are highly capitalized.

Keywords: Uncertainty Shocks; Financial Frictions; Relationship Banking; Bank Loan Rate Setting; Information Acquisition (search for similar items in EconPapers)
JEL-codes: E32 E43 E44 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-mac
Date: 2017-06-23
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Working Paper: Uncertainty and the Cost of Bank vs. Bond Finance (2019) Downloads
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