Online from: 2009
Subject Area: Economics
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|Title:||Do markets “discipline” all banks equally?|
|Author(s):||Joa˜o A.C. Santos, (Research Department, Federal Reserve Bank of New York, New York, New York, USA)|
|Citation:||Joa˜o A.C. Santos, (2009) "Do markets “discipline” all banks equally?", Journal of Financial Economic Policy, Vol. 1 Iss: 1, pp.107 - 123|
|Keywords:||Banks, Financial markets, Risk analysis|
|Article type:||Research paper|
|DOI:||10.1108/17576380910962402 (Permanent URL)|
|Publisher:||Emerald Group Publishing Limited|
|Acknowledgements:||JEL classification – E44, G32. The author thanks Adam Ashcraft, Scott Frame, and seminar participants at the Federal Reserve Bank of New York for useful comments and suggestions, and Chris Metli and Kyle Lewis for outstanding research assistance. The views stated herein are those of the author and are not necessarily the views of the Federal Reserve Bank of New York or the Federal Reserve System.|
Purpose – The purpose of this paper is to investigate whether the bond market disciplines all banks equally, in the sense of demanding the same relative risk premium across banks of different risk over the business cycle.
Design/methodology/approach – To test this hypothesis, the paper compares the difference between the credit spreads in the primary market of bank and firm bonds with the same credit rating issued during expansions with that same difference of spreads for bonds issued during recessions.
Findings – The paper finds that during recessions investors demand higher risk premiums. Importantly, the paper finds that the impact of recessions is not uniform across banks – it affects riskier banks more than safer ones. In other words, in recessions investors are relatively more demanding on riskier banks than on safer ones.
Originality/value – These findings are novel. They also have important policy implications because they show that a bond-issuance policy aimed at promoting market discipline could affect the relative funding costs of banks over the business cycle. They also indicate that the information which can be extracted from the credit spreads on bank bonds varies across banks for reasons unrelated to their risk.
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