A key driver for the mixed relationship between loan risk premiums and collateral: Evidence from China

Xuan Zhang, Yongmin Zhang, Eric Scheffel, Yang Zhao

Research output: Journal PublicationArticlepeer-review

Abstract

In spite of both ex-ante adverse selection and ex-post moral hazard theories supporting this mixed observable relationship between loan risk premiums and collateral, any plausible explanation for this mixed result still remains conspicuously absent in the literature. Based on a novel Chinese bank loan dataset, we show that collateral is negatively correlated with loan risk premiums, which is consistent with the ex-ante theory. However, after controlling for the purpose of the loan, mixed relationships between collateral and loan risk premiums for different types of collateral are obtained. The specific loan purpose plays an important role in determining loan risk premiums. We demonstrate that the mixed empirical results found in the existing literature to date may result from different economic characteristics of both collateral type and loan purpose, wherein particular liquidity may be of first-order importance in finally helping to demystify the mixed relationships.

Original languageEnglish
Article number102206
JournalInternational Review of Financial Analysis
Volume83
DOIs
Publication statusPublished - Oct 2022

Keywords

  • Banks
  • Collateral
  • Loan risk premium

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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