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Tests of a Signaling Hypothesis: The Choice between Fixed- and Adjustable-Rate Debt

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  • Guedes, Jose
  • Thompson, Rex

Abstract

We develop a model wherein the choice between adjustable- and fixed-rate debt can serve as a signal of firm quality. The nature of the signal depends on expected inflation volatility relative to other risk parameters. Evidence from a matched sample of debt announcements over the period 1978 to 1986 shows a difference of [minus]2.05 percent between stock price reactions to adjustable rate and fixed rate announcements when expected inflation volatility is above an estimated threshold. Below this threshold, the difference is [plus]0.98 percent. The evidence supports the hypothesis that the riskier debt choice serves as a favorable signal of firm quality. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Guedes, Jose & Thompson, Rex, 1995. "Tests of a Signaling Hypothesis: The Choice between Fixed- and Adjustable-Rate Debt," The Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 605-636.
    • Handle: RePEc:oup:rfinst:v:8:y:1995:i:3:p:605-36
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    Cited by:

    1. Vickery, James, 2008. "How and why do small firms manage interest rate risk," Journal of Financial Economics, Elsevier, vol. 87(2), pages 446-470, February.
    2. Lisa L. Posey & Paul D. Thistle, 2017. "Automobile Insurance and Driver Ability: Contract Choice as a Screening Mechanism," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 42(2), pages 141-170, September.
    3. Oberoi, Jaideep, 2018. "Interest rate risk management and the mix of fixed and floating rate debt," Journal of Banking & Finance, Elsevier, vol. 86(C), pages 70-86.
    4. Ajay Kalra & Shibo Li, 2008. "Signaling Quality Through Specialization," Marketing Science, INFORMS, vol. 27(2), pages 168-184, 03-04.
    5. Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
    6. Lisa L. Posey & Paul D. Thistle, 2017. "Automobile Insurance and Driver Ability: Contract Choice as a Screening Mechanism," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 42(2), pages 141-170, September.
    7. James Vickery, 2005. "How and why do small firms manage interest rate risk? Evidence from commercial loans," Staff Reports 215, Federal Reserve Bank of New York.
    8. Chava, Sudheer & Purnanandam, Amiyatosh, 2007. "Determinants of the floating-to-fixed rate debt structure of firms," Journal of Financial Economics, Elsevier, vol. 85(3), pages 755-786, September.

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