Working Paper: NBER ID: w15653
Abstract: This paper models a firm's rollover risk generated by conflict of interest between debt and equity holders. When the firm faces losses in rolling over its maturing debt, its equity holders are willing to absorb the losses only if the option value of keeping the firm alive justifies the cost of paying off the maturing debt. Our model shows that both deteriorating market liquidity and shorter debt maturity can exacerbate this externality and cause costly firm bankruptcy at higher fundamental thresholds. Our model provides implications on liquidity-spillover effects, the flight-to-quality phenomenon, and optimal debt maturity structures.
Keywords: Rollover risk; Credit risk; Market liquidity; Debt maturity
JEL Codes: G01; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Deteriorating market liquidity (E44) | Increased likelihood of default (G33) |
| Increased likelihood of default (G33) | Ceasing to service debt (H63) |
| Ceasing to service debt (H63) | Default when equity value reaches zero (G33) |
| Shorter debt maturities (G19) | Increased frequency of rollovers (E32) |
| Increased frequency of rollovers (E32) | Increased financial burden on equity holders (G32) |