Can Equity Volatility Explain the Global Loan Pricing Puzzle?∗

We examine whether equity volatility can explain the difference in syndicated corporate loan spreads paid by U.S. and European borrowers first documented by Carey and Nini (2007). We argue that OLS estimates of the association between equity volatility and loan spreads are biased and inconsistent. We suggest instrumental variables that potentially identify consistent estimates. Our instrumental variable results indicate that there is no statistically significant difference in loan spreads paid by U.S. and European borrowers, and that OLS estimates of the association between idiosyncratic equity volatility and corporate loan spreads are biased downward by about a factor of 5. JEL codes: E40, G12, G15, G21 In this paper we examine whether equity volatility can explain the difference in syndicated corporate loan spreads between the U.S. and Europe documented by previous research. Carey and Nini (2007) provide evidence that interest rates spreads in Europe are 30 basis points ∗The views expressed in this paper are those of the authors alone and do not necessarily reflect those of the Office of the Comptroller of the Currency or the U.S. Department of the Treasury. †Financial Economist, Policy Analysis Division, Office of the Comptroller of the Currency, 250 E St. SW, 3rd Floor, Washington, DC 20219, e-mail: [email protected] ‡Post-doctoral Fellow, École Polytechnique Fédérale de Lausanne (EPFL), Chair of International Finance, Station 5, Office ODY 2.17, CH 1015 Lausanne, Switzerland, e-mail: [email protected]