Credit Derivatives and Loan Pricing

by Lars Norden of Mannheim University, and
Wolf Wagner of Tilburg University & Cambridge University

February 23, 2007

Abstract: This paper examines the relationship between the new markets for credit default swaps (CDS) and the pricing of syndicated loans to U.S. corporates. We find that changes in CDS spreads have a significantly positive coefficient and explain about 25% of subsequent monthly changes in aggregate loan spreads during 2000-2005. Moreover, when compared to traditional loan pricing factors, they turn out to be the dominant determinant of loan spreads. In particular, they explain loan rates much better than same rated bonds. This suggests that, even though CDS and bond markets may equally price market credit risk, a substantial part of CDS prices additionally contains loan-specific information. We also find that, over time, new information from CDS markets is incorporated into loans faster, but information from other markets does not. We argue that this indicates that the markets for CDS influence banks' loan pricing behavior and thus have an impact on actual financing decisions in the economy.

JEL Classification: G10, G21.

Keywords: Syndicated Lending, Loan Rates, Credit Derivatives, Credit Markets, Credit Spreads.

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