Market discipline in the banking industry: evidence from spread dispersion

Do bond investors price hidden information? This paper addresses this question by using a heteroscedastic regression model to empirically examine the factors affecting the spread dispersion unexplained by easy-to-observe issue characteristics (credit ratings, size, maturity, etc.). First, variables that predict quite accurately the spread for the typical bond, lose their explanatory power for worse-rated, subordinated bonds with longer maturity and smaller face value. This result suggests that investors price hidden information. Second, spread unexplained dispersion increases for open-priced offers, indicating that this price-setting mechanism enhance investors’ ability to uncover hidden information. Finally, contrary to prediction, spread unexplained dispersion decreases with the number of banks involved in the syndicate.