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Do markets “discipline” all banks equally?


  • Joa˜o A.C. Santos


Purpose - The purpose of this paper is to investigate whether the bond market disciplines all banks equally, in the sense of demanding the same relative risk premium across banks of different risk over the business cycle. Design/methodology/approach - To test this hypothesis, the paper compares the difference between the credit spreads in the primary market of bank and firm bonds with the same credit rating issued during expansions with that same difference of spreads for bonds issued during recessions. Findings - The paper finds that during recessions investors demand higher risk premiums. Importantly, the paper finds that the impact of recessions is not uniform across banks – it affects riskier banks more than safer ones. In other words, in recessions investors are relatively more demanding on riskier banks than on safer ones. Originality/value - These findings are novel. They also have important policy implications because they show that a bond-issuance policy aimed at promoting market discipline could affect the relative funding costs of banks over the business cycle. They also indicate that the information which can be extracted from the credit spreads on bank bonds varies across banks for reasons unrelated to their risk.

Suggested Citation

  • Joa˜o A.C. Santos, 2009. "Do markets “discipline” all banks equally?," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 1(1), pages 107-123, April.
  • Handle: RePEc:eme:jfeppp:v:1:y:2009:i:1:p:107-123

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    References listed on IDEAS

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    8. Ignacio Lozano & Jorge Toro, 2007. "Fiscal Policy Throughout the Cycle: The Colombian Experience," BORRADORES DE ECONOMIA 002730, BANCO DE LA REPÚBLICA.
    9. Pappa, Evi, 2005. "New-keynesian or RBC transmission? The effects of fiscal shocks in labour markets," LSE Research Online Documents on Economics 524, London School of Economics and Political Science, LSE Library.
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    11. Olivier Blanchard & Roberto Perotti, 2002. "An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output," The Quarterly Journal of Economics, Oxford University Press, vol. 117(4), pages 1329-1368.
    12. Baxter, Marianne & King, Robert G, 1993. "Fiscal Policy in General Equilibrium," American Economic Review, American Economic Association, vol. 83(3), pages 315-334, June.
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    Cited by:

    1. Adrian Pop, 2009. "Beyond the Third Pillar of Basel Two: Taking Bond Market Signals Seriously," Working Papers hal-00419241, HAL.
    2. Luc Laeven, 2011. "Banking Crises: A Review," Annual Review of Financial Economics, Annual Reviews, vol. 3(1), pages 17-40, December.

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    Banks; Risk analysis; Financial markets;


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