Yields on Privately Place Corporate Bonds.

In many highly organized financial markets, investors can substitute easily between alternative financial assets. Differences in asset yields tend to reflect differences in term to maturity (or duration), in risk arising either from possible default or from illiquidity, or in the tax treatment of investment returns. During the 1961–77 period, the average yield on privately placed corporate bonds exceeded those on publicly issued corporate bonds—of roughly similar quality, duration, and tax treatment—by about 50 basis points. Higher flotation costs in public offerings and increased flexibility for borrowers in private placements account for most of this average private-public yield spread of 50 basis points. However, the level of the spread did not remain fixed at 50 basis points but varied over the 1961–77 period from a quarterly low of 5 basis points in 1970:2 to a quarterly high of 94 basis points in 1962:4. While lower flotation costs and greater convenience seem adequate to explain most of the average private-public yield spread, changes in relative cost and convenience do not seem sufficient to explain changes in the spread. The purpose of this paper is to analyze private placement yields relative to yields on public offerings of roughly similar quality and duration. The parameters of a reduced form private placement yield model are estimated using quarterly data from the 1961–74 period. The empirical results indicate how private placement rates, relative to public rates, are affected by the level of the public rate, changes in this rate, the supply of credit relative to demand in the private market, and interest rate expectations adjusted for uncertainty about future rates. These results provide information about the degree of segmentation between the private and public markets, the impact of interest rate expectations and uncertainty about future rates on private placement rate negotiations, and the rate of adjustment o... [ABSTRACT FROM AUTHOR]