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

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 the11/1999-06/2002 period. We find evidence consistent with a monitoring role of loans. First, 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 reaction of loans is less adverse than that of bonds around loan and bond default dates. Second, we find evidence that the difference in price reaction of loans versus bonds is amplified around loan default dates that are not preceded by a bond default date of the same company. Finally, we find a higher recovery rate for loans as compared to bonds, suggesting that the monitoring role of loans does not diminish significantly in the post default period. Our results are robust to controlling for security-specific characteristics, such as seniority, and collateral, and for multiple measures of cumulative abnormal returns around default dates. Overall, we find that the loan market is informationally more efficient than the bond market around default dates