The Determinants of Yield Spreads and the Market Discipline of Banks

44 Pages Posted: 1 Mar 2009

See all articles by Ken B. Cyree

Ken B. Cyree

University of Mississippi - School of Business Administration

Bhanu Balasubramanian

University of Akron - College of Business Administration - Department of Finance

Date Written: February 28, 2009

Abstract

Determinants of yield spreads vary with market conditions and available information, which has implications for debt pricing models. After the bailout of Long Term Capital Management (LTCM) in September 1998, important firm-specific default risk measures, such as leverage, are not significant factors in determining yield spread levels of bank-issued subordinated notes and debentures (SND) because these measures do not reflect the true risk of the firm. Bond markets impound a higher cost for higher risk-taking, particularly for off-balance sheet risks, based on return-on-assets, after the LTCM bailout, Yield spreads have become less sensitive to firm-specific risks, even prior to the LTCM bailout, after the issuance of trust-preferred securities (TPS) by banks because TPS are junior claims to SND and provide an additional buffer to SND from default risk. Yield spreads on SND prior to TPS issuance by banks and the LTCM bailout are sensitive to conventional firm-specific risk measures. Yield spreads on TPS at the time of offer provide market signals about on-balance sheet risks.

Keywords: Yield Spread, Default risk, Market Discipline of banks, Market monitoring, Credit risk

Suggested Citation

Cyree, Ken B. and Balasubramanian, Bhanu, The Determinants of Yield Spreads and the Market Discipline of Banks (February 28, 2009). Available at SSRN: https://ssrn.com/abstract=1350951 or http://dx.doi.org/10.2139/ssrn.1350951

Ken B. Cyree

University of Mississippi - School of Business Administration ( email )

PO Box 3986
Oxford, MS 38677
United States

Bhanu Balasubramanian (Contact Author)

University of Akron - College of Business Administration - Department of Finance ( email )

259 S. Broadway
Akron, OH 44325
United States

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