Informational Efficiency of Loans versus Bonds

Informational Efficiency of Loans versus Bonds:
Evidence from Secondary Market Prices


December 2004

This paper examines the informational efficiency of loans relative to bonds using a unique dataset of daily secondary market prices of loans. We find that the loan market is informationally more efficient than the bond market prior to and surrounding information intensive events, such as corporate (loan and bond) defaults, and bankruptcies. Specifically, we find that loan prices fall more than bond prices prior to an event, and less than bond prices of the same borrower during a short time period surrounding an event. This evidence is consistent with a monitoring advantage of loans over bonds. Our results are robust to a different empirical methodology (Vector Auto Regression based Granger causality), and to alternative explanations which control for security-specific characteristics, such as seniority, collateral, recovery rates, liquidity, covenants, and for multiple measures of cumulative abnormal returns.

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