The Risk-Return Relation in the Corporate Loan Market

Abstract

This paper analyzes the hypothesis that returns play a risk-compensating role in the market for corporate revolving lines of credit. Specifically, we test whether borrower risk and the expected return on these debt instruments are positively related. Our main findings support this prediction, in contrast to the only previous work that examined this problem two decades ago. Nevertheless, we find evidence of mispricing regarding the risk of deteriorating firms using their facilities more intensively and during the subprime crisis.