The Effects of Financing Frictions in Investment-Grade Debt Markets
53 Pages Posted: 13 Nov 2017 Last revised: 15 Jan 2024
Date Written: July 27, 2020
Abstract
We show that investors reach for yield by taking more duration risk along with more credit risk. The two types of risk-taking behavior have opposite effects on borrowing firms. Higher credit risk-taking increases credit supply to riskier firms. Higher duration risk-taking by investors pushes firms to extend issuance maturity and pay higher interest rates to obtain capital. These firms reduce borrowing and investment as a result. The underlying mechanism is the presence of supply-side frictions in investment-grade corporate debt markets. The results suggest that policymakers should take investor risk choice into account when evaluating the stimulative benefits of low interest rates.
Keywords: Reaching for yield, Financing frictions, Debt maturity.
JEL Classification: G21, G23, G32.
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