Working Paper: CEPR ID: DP9930
Authors: Gur Huberman; Rafael Repullo
Abstract: We present a model of the maturity of a bank's uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank's risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.
Keywords: inefficient liquidation; long-term debt; optimal financial contracts; risk-shifting; rollover risk; short-term debt
JEL Codes: G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Short-term debt (H63) | risk-taking behavior (D91) |
| Moral hazard (G52) | risk-shifting (H22) |
| Market conditions (D49) | choice of debt maturity (H63) |
| Short-term debt (H63) | liquidation efficiency (G33) |
| Quality of lenders' information (G21) | conditions for short-term debt feasibility (F34) |
| Liquidation costs (G33) | conditions for short-term debt feasibility (F34) |
| High-quality information + high recovery rates (L15) | preference for short-term debt (G19) |
| Long-term debt (H63) | riskier investments (G11) |