We extract cost of capital measures for banks using analyst earnings forecasts, which we show are unbiased. We find that the cost of equity and the cost of debt decrease in the Tier 1 ratio, whereas total cost of capital is uncorrelated with the Tier 1 ratio. These findings suggest that investors adjust their return expectations for banks in accordance with the Modigliani–Miller conservation‐of‐risk principle. Hence, increased capital requirements are not made socially costly based on a notion that market pricing violates risk conservation. Equity can nevertheless still be privately costly for banks because of reduced subsidies.

Liquidity provision for corporate bonds has become significantly more expensive after the 2008 crisis. Using index exclusions as a natural experiment during which uninformed index trackers request immediacy, we find that the cost of immediacy has more than doubled. In addition, the supply of immediacy has become more elastic with respect to its price. Consistent with a stringent regulatory environment incentivizing smaller dealer inventories, we also find that dealers revert deviations from their target inventory more quickly after the crisis. Finally, we investigate the pricing impact of information, changes in ownership structure, and differences between bank and nonbank dealers. Received February 22, 2017; editorial decision May 29, 2018 by Editor Itay Goldstein.

We show that bonds issued by financial firms have higher spreads than bonds issued by industrial firms with the same rating and maturity, a difference that we refer to as the financial premium. Over the period 1987 to 2020, in the United States, this premium is 43 basis points on average, with the premium higher for lower ratings, higher during financial crises, and increasing in bond beta. We derive a model that explains the financial premium: banks hold diversified portfolios of nonfinancial debt, and bank debt therefore reflects more systematic risk than nonfinancial debt.

We show that corporate bond issuers benefit from utilizing existing underwriter relationships when rolling over bonds, but at the same time become exposed to underwriter distress. A strong relationship enables the underwriter to credibly certify the issuer resulting in lower direct issuance costs and lower underpricing. However, if the underwriter becomes distressed, this spills over to the issuer's credit risk, because it weakens the relationship and increases the risk of involuntary relationship termination. The credit risk spillover is more pronounced for risky, information-sensitive issuers with high rollover exposure, i.e., those issuers most in need of certification by an underwriter.

We analyze liquidity components of corporate bond spreads during 2005–2009 using a new robust illiquidity measure. The spread contribution from illiquidity increases dramatically with the onset of the subprime crisis. The increase is slow and persistent for investment grade bonds while the effect is stronger but more short-lived for speculative grade bonds. Bonds become less liquid when financial distress hits a lead underwriter and the liquidity of bonds issued by financial firms dries up under crises. During the subprime crisis, flight-to-quality is confined to AAA-rated bonds.