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

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  • Michael J. Dueker
  • Daniel L. Thornton

Abstract

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.

Suggested Citation

  • Michael J. Dueker & Daniel L. Thornton, 1994. "Asymmetry in the prime rate and firms' preference for internal finance," Working Papers 1994-017, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:1994-017
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    References listed on IDEAS

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    Cited by:

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    2. Kobayashi, Teruyoshi, 2009. "Announcements and the effectiveness of monetary policy: A view from the US prime rate," Journal of Banking & Finance, Elsevier, vol. 33(12), pages 2253-2266, December.
    3. Li, Xiao-Lin & Si, Deng-Kui & Ge, Xinyu, 2021. "China’s interest rate pass-through after the interest rate liberalization: Evidence from a nonlinear autoregressive distributed lag model," International Review of Economics & Finance, Elsevier, vol. 73(C), pages 257-274.

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    Corporations - Finance; Prime rate;

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