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The Credit Spread Cycle with Matching Friction

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  • Fabien Tripier

    (University of Nantes)

  • Kevin E. Beaubrun-Diant

    (University Paris Dauphine)

Abstract

We herein advance a contribution to the theoretical literature on financial frictions and show the significance of the matching mechanism in explaining the countercyclical behavior of interest rate spreads. We demonstrate that when matching friction is associated with a Nash bargaining solution, it provides a satisfactory explanation of the credit spread cycle in response to shocks in production technology. During periods of expansion, the credit spread experiences a tightening for two reasons. Firstly, as a result of easier access to loans, entrepreneurs have better opportunities outside a given lending relationship and can negotiate lower interest rates. Secondly, the less selective behavior of entrepreneurs and banks results in the occurrence of fewer productive matches, a fall in the average productivity of matches, and a tightening of the credit spread.

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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 76.

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Date of creation: 2010
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Handle: RePEc:red:sed010:76

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