Credit derivatives and loan pricing

This paper examines the relation between the new markets for credit default swaps (CIDS) and banks' pricing of syndicated loans to US 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 explanatory 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 CDS prices contain, beyond general credit risk. to a substantial extent information relevant for bank lending. We also find that, over time, new information from CDs markets is faster incorporated into loans, but information from other markets is not. Overall, our results indicate that the markets for CDS have gained an important role for banks. (C) 2008 Elsevier B.V. All rights reserved.