Financial market determinants of the real cost of funds to public corporations in the US

Abstract

Purpose The purpose of this study is to provide new empirical evidence on the impact of a variety of financial market forces on the ex post real cost of funds to corporations, namely, the ex post real interest rate yield on AAA-rated long-term corporate bonds in the USA. The study is couched within an open-economy loanable funds model, and it adopts annual data for the period 1973-2013, so that the results are current while being applicable only for the post-Bretton Woods era. The auto-regressive two-stage least squares (2SLS) and generalized method of moments (GMM) estimations reveal that the ex post real interest rate yield on AAA-rated long-term corporate bonds in the USA was an increasing function of the ex post real interest rate yields on six-month Treasury bills, seven-year Treasury notes, high-grade municipal bonds and the Moody’s BAA-rated corporate bonds, while being a decreasing function of the monetary base as a per cent of gross domestic product (GDP) and net financial capital inflows as a per cent of GDP. Finally, additional estimates reveal that the higher the budget deficit as a per cent of GDP, the higher the ex post real interest rate on AAA-rated long-term corporate bonds. Design/methodology/approach After developing an initial open-economy loanable funds model, the empirical dimension of the study involves auto-regressive, two-stage least squares and GMM estimates. The model is then expanded to include the federal budget deficit, and new AR/2SLS and GMM estimates are provided. Findings The AR/2SLS and GMM (generalized method of moments) estimations reveal that the ex post real interest rate yield on AAA-rated long-term corporate bonds in the USA was an increasing function of the ex post real interest rate yields on six-month Treasury bills, seven-year Treasury notes, high-grade municipal bonds and the Moody’s BAA-rated corporate bonds, while being a decreasing function of the monetary base as a per cent of GDP and net financial capital inflows as a per cent of GDP. Finally, additional estimates reveal that the higher the budget deficit as a per cent of GDP, the higher the ex post real interest rate on AAA-rated long -term corporate bonds. Originality/value The author is unaware of a study that adopts this particular set of real interest rates along with net capital inflows and the monetary base as a per cent of GDP and net capital inflows. Also, the data run through 2013. There have been only studies of deficits and real interest rates in the past few years.