Dynamic Debt Runs

Abstract:     
We develop a dynamic model of panic debt runs on a non-bank financial firm, which invests in an illiquid asset by rolling over short-term debt. The firm has a time-varying fundamental and a staggered debt structure (i.e., different debt contracts mature at different times.) We derive a unique threshold equilibrium, in which creditors coordinate their asynchronous rollover decisions based on the publicly observable fundamental. Fundamental fluctuation generates creditors' concerns about the firm's future rollover risk. The coordination problem between creditors amplifies the concerns and causes each maturing creditor to run ahead of others even when the firm fundamental is substantially higher than its liability. Our model provides a set of implications on the roles played by volatility, illiquidity and debt maturity in driving debt runs, as well as on firms' capital adequacy standards and credit risk.

Working Paper Series