Can Equity Volatility Explain the Global Loan Pricing Puzzle?

Abstract:     
In this paper we hypothesize that unobservable differences in firm volatility are responsible for the difference in syndicated corporate loan spreads paid by U.S. and European firms. To explore this hypothesis, we examine whether equity volatility, an error prone measure of firm volatility in financial markets, can explain the difference in syndicated corporate loan spreads paid by U.S. and European borrowers. We argue that controlling for equity volatility in OLS regressions will result in biased and inconsistent estimates of the difference in U.S. and European loan spreads because the error in measuring firm volatility with equity volatility will produce biased and inconsistent coefficient estimates for any variable correlated with firm volatility. Therefore, we use instrumental variables methods to solve the measurement error problem and identify consistent estimates of the difference in U.S. and European loan spreads. In our instrumental variable results, we find no statistically significant difference in U.S. and European loan spreads.

Number of Pages in PDF File: 90

Keywords: syndicated loans, equity volatility, loan spread

JEL Classification: E40, G12, G15, G21

working papers series