The Mechanisms of Loan Market Efficiency

Abstract

This article develops an account of the mechanisms of efficiency of corporate loan markets or the secondary markets in which loans made to corporate borrowers are traded. In our account: 1) professionally informed trading incorporating information about the quality of the loan terms offered to borrowers, is the primary source of corporate loan market efficiency, and 2) antitrust law is among the principal policy tools that can foster loan market efficiency by policing market participants' efforts to restrict activist loan market investors from accessing information in the loan market. The main objective of fostering loan market efficiency is to allow activist investors incorporate information about the erosion of the quality of the underwritten terms into loan prices and prompt corrections in mispricing in primary markets thereby contributing to the tightening of the terms subsequently offered in primary markets. From a policy perspective, efficient loan markets can help alleviate the concerns around the erosion of underwriting standards that have become widespread in recent years.

Keywords: loan markets, market efficiency, covenants, cov-lite, LSTA

JEL Classification: G11, G12, G14, G15, G18, G21, G23, L41, L44