EVIDENCE OF BANK MARKET DISCIPLINE IN SUBORDINATED DEBENTURE YIELDS -1983-1991

We examine debenture yields over the period 1983-1991 to evaluate the market's sensitivity to bank-specific risks, and conclude that investo rs have rationally reflected changes in the government's policy toward absorbing private losses in the event of a bank failure. Although thi s evidence does not establish that market discipline can effectively c ontrol banking firms, it soundly rejects the hypothesis that investors cannot rationally differentiate among the risks undertaken by the maj or U.S. banking firms.