Working Paper: NBER ID: w27195
Authors: Michael R. Roberts; Michael Schwert
Abstract: We show that the partial response of loan rates to interest rate changes, referred to in the bank lending literature as “stickiness,” is a feature of perfect capital markets. No-arbitrage models of credit risk are able to replicate empirical interest rate sensitivities. However, the widespread use of interest rate floors in the low-rate environment of the last decade is a result of risk-sharing and incentive considerations arising from market imperfections. Floors reallocate cash flows across states in a way that loan spreads cannot. They insure lenders against losses if rates fall, while mitigating borrower moral hazard if rates rise.
Keywords: Interest Rates; Financial Contracts; Leveraged Loans; Loan Pricing
JEL Codes: E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Interest Rates (E43) | Loan Rates (E43) |
| Interest Rates (E43) | Loan Spreads (G51) |
| Interest Rate Floors (E43) | Loan Contracts (K12) |
| Interest Rates (E43) | Probability of Including a Floor (C29) |
| Interest Rate Floors (E43) | Moral Hazard Problems (D82) |