A NOTE ON THE SPREAD BETWEEN THE RATES OF FIXED AND VARIABLE-RATE LOANS

An expression of the optimal expected spread between the rates of fixed and variable rate loans offered by a competitive risk-averse bank is derived. We find that the expected spread varies directly with the volatility of the funding cost, the bank's degree of risk aversion, and the competitive profit margin on variable rate loans. Our analysis also characterizes the optimal mix of fixed and variable rate lending in a bank's loan portfolio.