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Uncertainty and the Cost of Bank versus Bond Finance

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  • CHRISTIAN GRIMME

Abstract

How does uncertainty affect the costs of raising finance in the bond market and via bank loans? Empirically, this paper finds that heightened uncertainty is accompanied by an increase in corporate bond spreads, whereas spreads on bank loans remain unchanged. This finding can be explained with a model that includes costly state verification and in which banks maintain long‐term relationships with borrowers and acquire information beyond what is publicly available. After an unexpected increase in uncertainty, the probability of borrower default increases. Banks leave the loan spread unchanged to maintain the relationship. In contrast, bond spreads increase because investors demand compensation for the increased default risk.

Suggested Citation

  • Christian Grimme, 2023. "Uncertainty and the Cost of Bank versus Bond Finance," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(1), pages 143-169, February.
    • Handle: RePEc:wly:jmoncb:v:55:y:2023:i:1:p:143-169
    DOI: 10.1111/jmcb.12911
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