What Does the Yield on Subordinated Bank Debt Measure?
We provide evidence that a bank's subordinated debt yield spread is not, by itself, a sufficient measure of default risk. We use a model in which subordinated debt is held by investors with superior knowledge (informed investor). First, we show that in theory the yield spread on subordinated debt must compensate investors for expected loss plus give them an incentive not to prefer senior debt. Second we present strong empirical evidence in favor of the informed investor hypothesis and of the existence of the incentive premium predicted by the model. Using data on the timing and pricing of public debt issues made by large U.S. banking organizations during the 1985-2002 period, we find that banks issue relatively more subordinated debt in good times, i.e. when informed investors have good news. Spreads at issuance (corrected for sample selection bias) react to (superior) private and to public information, in line with the comparative statics of the postulated incentive premium. Interestingly, as the model predicts, the influence of sophisticated investors' information on the subordinated yield spread became weaker after the introduction of prompt corrective action and depositor preference reforms, while the influence of public risk perception grew stronger. Finally, our model explains anomalies from the empirical literature on subordinated debt spreads and from market interviews (e.g. limited sensitivity to bank-specific risk and the ballooning of spreads in bad times). We conclude that a bank's subordinated yield spread conveys important information if interpreted together with its senior spread and with other banks' subordinated yield spreads.
|Date of creation:||2004|
|Date of revision:|
|Contact details of provider:|| Postal: |
Phone: +41 44 631 31 11
Fax: +41 44 631 39 11
Web page: http://www.snb.ch/en/ifor/research/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Douglas D. Evanoff & Larry D. Wall, 2000. "Subordinated debt as bank capital: a proposal for regulatory reform," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q II, pages 40-53.
- Diamond, Douglas W., 1993. "Seniority and maturity of debt contracts," Journal of Financial Economics, Elsevier, vol. 33(3), pages 341-368, June.
- Andrea Sironi, 2001.
"An Analysis of European Banks' SND Issues and its Implications for the Design of a Mandatory Subordinated Debt Policy,"
Journal of Financial Services Research,
Springer, vol. 20(2), pages 233-266, October.
- Andrea Sironi, 2000. "An analysis of European banks SND issues and its implications for the design of a mandatory subordinated debt policy," Finance and Economics Discussion Series 2000-41, Board of Governors of the Federal Reserve System (U.S.).
- Douglas Evanoff & Larry Wall, 2001.
"Sub-debt Yield Spreads as Bank Risk Measures,"
Journal of Financial Services Research,
Springer, vol. 20(2), pages 121-145, October.
- anonymous, 1999. "Using subordinated debt as an instrument of market discipline," Staff Studies 172, Board of Governors of the Federal Reserve System (U.S.).
- Diana Hancock & Myron L. Kwast, 2001. "Using subordinated debt to monitor bank holding companies: is it feasible?," Finance and Economics Discussion Series 2001-22, Board of Governors of the Federal Reserve System (U.S.).
- Calomiris, Charles W., 1999. "Building an incentive-compatible safety net," Journal of Banking & Finance, Elsevier, vol. 23(10), pages 1499-1519, October.
- Diana Hancock & Myron Kwast, 2001. "Using Subordinated Debt to Monitor Bank Holding Companies: Is it Feasible?," Journal of Financial Services Research, Springer, vol. 20(2), pages 147-187, October.
- Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
- Reynard, Samuel, 2004.
"Financial market participation and the apparent instability of money demand,"
Journal of Monetary Economics,
Elsevier, vol. 51(6), pages 1297-1317, September.
- Samuel Reynard, 2004. "Financial Market Participation and the Apparent Instability of Money Demand," Working Papers 2004-01, Swiss National Bank.
- Winton, Andrew, 1995. "Costly State Verification and Multiple Investors: The Role of Seniority," Review of Financial Studies, Society for Financial Studies, vol. 8(1), pages 91-123.
- Karl B. Diether & Christopher J. Malloy & Anna Scherbina, 2002. "Differences of Opinion and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2113-2141, October.
- Birchler, Urs W, 2000.
"Bankruptcy Priority for Bank Deposits: A Contract Theoretic Explanation,"
Review of Financial Studies,
Society for Financial Studies, vol. 13(3), pages 813-40.
- Urs W. Birchler, 1999. "Bankruptcy Priority for Bank Deposits: a Contract Theoretic Explanation," Working Papers 00.01, Swiss National Bank, Study Center Gerzensee.
- Barclay, Michael J & Smith, Clifford W, Jr, 1995. " The Priority Structure of Corporate Liabilities," Journal of Finance, American Finance Association, vol. 50(3), pages 899-917, July.
- Pierre Collin-Dufresne, 2001. "The Determinants of Credit Spread Changes," Journal of Finance, American Finance Association, vol. 56(6), pages 2177-2207, December.
- Mark Fisher & Douglas Nychka & David Zervos, 1995. "Fitting the term structure of interest rates with smoothing splines," Finance and Economics Discussion Series 95-1, Board of Governors of the Federal Reserve System (U.S.).
- Campbell-Pownall, R.A.J. & Huisman, R., 2002. "Measuring Credit Spread Risk," ERIM Report Series Research in Management ERS-2002-95-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
When requesting a correction, please mention this item's handle: RePEc:snb:snbwpa:2004-02. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Enzo Rossi)
If references are entirely missing, you can add them using this form.