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Asymmetry in the prime rate and firms' preference for internal finance

  • Michael Dueker
  • Daniel L. Thornton

This article tests for asymmetry in thebehavior of bank lending rates by testing the hypothesis that the prime rate responds more fully and quickly to increase than decreases in market interest rates. The econometric methodology used is better suited to the discreteness and rigidity of the prime rate than that of previous studies. Our results suggest that banks adjust the prime rate asymmetrically in response to change in the discount rate, the commercial paper rate, and the spread between the prime and commercial paper rates. Asymmetry in bank lending rates is implied by several explanations for the preference among small firms for internal finance. Asymmetry in bank lending rates may result from the fact that individual banks have acquired costly information which prevents their customers from responding quickly to changes in loan terms, or it may stem from a cyclical "lemons" premium resulting from informational asymmetries [Oliner and Rudebusch (1992)]. Either way, asymmetric behavior of bank lending rates, such as the prime rate, may be part of a more complete explanation of small firms' preference for internal finance.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 1994-017.

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Date of creation: 1994
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Handle: RePEc:fip:fedlwp:1994-017
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  1. Stephen D. Oliner & Glenn D. Rudebusch, 1993. "Is there a bank credit channel for monetary policy?," Finance and Economics Discussion Series 93-8, Board of Governors of the Federal Reserve System (U.S.).
  2. Steven M. Fazzari & Bruce C. Petersen, 1993. "Working Capital and Fixed Investment: New Evidence on Financing Constraints," RAND Journal of Economics, The RAND Corporation, vol. 24(3), pages 328-342, Autumn.
  3. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  4. Mark L. Gertler, 1988. "Financial Structure and Aggregate Economic Activity: An Overview," NBER Working Papers 2559, National Bureau of Economic Research, Inc.
  5. Hausman, J.A. & Lo, A.W. & MacKinlay, A.C., 1991. "An Ordered Probit Analysis of Transaction Stock Prices," Weiss Center Working Papers 26-91, Wharton School - Weiss Center for International Financial Research.
  6. Ben Bernanke, 1990. "The Federal Funds Rate and the Channels of Monetary Transnission," NBER Working Papers 3487, National Bureau of Economic Research, Inc.
  7. Mark Gertler & Simon Gilchrist, 1991. "Monetary Policy, Business Cycles and the Behavior of Small Manufacturing Firms," NBER Working Papers 3892, National Bureau of Economic Research, Inc.
  8. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers 95-29, Columbia - Graduate School of Business.
  9. Donald P. Morgan, 1992. "Are bank loans a force in monetary policy?," Economic Review, Federal Reserve Bank of Kansas City, issue Q II, pages 31-41.
  10. Daniel L. Thornton, 1992. "Why do T-bill rates react to discount rate changes?," Working Papers 1992-004, Federal Reserve Bank of St. Louis.
  11. Cook, Timothy & Hahn, Thomas, 1988. "The Information Content of Discount Rate Announcements and Their Effect on Market Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 167-80, May.
  12. Cover, James Peery, 1992. "Asymmetric Effects of Positive and Negative Money-Supply Shocks," The Quarterly Journal of Economics, MIT Press, vol. 107(4), pages 1261-82, November.
  13. Ben S. Bernanke & Cara S. Lown, 1991. "The Credit Crunch," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 22(2), pages 205-248.
  14. Anil K. Kashyap & Jeremy C. Stein & David W. Wilcox, 1991. "Monetary policy and credit conditions: evidence from the composition of external finance," Finance and Economics Discussion Series 154, Board of Governors of the Federal Reserve System (U.S.).
  15. Timothy H. Hannan, 1989. "Foundations of the structure-conduct-performance paradigm," Finance and Economics Discussion Series 83, Board of Governors of the Federal Reserve System (U.S.).
  16. Forbes, Shawn M. & Mayne, Lucille S., 1989. "A friction model of the prime," Journal of Banking & Finance, Elsevier, vol. 13(1), pages 127-135, March.
  17. Hannan, Timothy H, 1991. "Foundations of the Structure-Conduct-Performance Paradigm in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(1), pages 68-84, February.
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