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Informational Efficiency of Loans Versus Bonds: Evidence from Secondary Market Prices

by Edward Altman of New York University,
Amar Gande of Vanderbilt University, and
Anthony Saunders of New York University

December 2004

Abstract: This paper examines the informational efficiency of loans relative to bonds surrounding loan default dates and bond default dates. We examine this issue using a unique dataset of daily secondary market prices of loans over the 11/1999-06/2002 period. We find evidence consistent with a monitoring role of loans. Specifically, consistent with a view that the monitoring role of loans should be reflected in more precise expectations embedded in loan prices, we find that the price decline of loans is less adverse than that of bonds of the same borrower around loan and bond default dates. Additionally, we find evidence that the difference in price decline of loans versus bonds is amplified around loan default dates that are not preceded by a bond default date of the same company. Our results are robust to several alternative explanations, and to controlling for security-specific characteristics, such as seniority, collateral, covenants, and for multiple measures of cumulative abnormal returns. Overall, we find that the loan market is informationally more efficient than the bond market around loan default dates and bond default dates.

JEL Classification: G14, G21, G22, G23, G24.

Keywords: monitoring, default, spillovers, event study, loans, bonds, stocks.

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