Rollover Risk and Market Freezes

Rollover Risk and Market Freezes

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Article ID: iaor201112079
Volume: 66
Issue: 4
Start Page Number: 1177
End Page Number: 1209
Publication Date: Aug 2011
Journal: The Journal of Finance
Authors: , ,
Keywords: debt
Abstract:

The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short‐term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy‐to‐hold investor. We then show that a small change in the asset’s fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.

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