Liquidity and Feasible Debt Relief

45 Pages Posted: 20 Feb 2009

See all articles by Josef Zechner

Josef Zechner

Vienna University of Economics and Business

Chris Hennessy

London Business School

Date Written: February 15, 2009


This paper analyzes the determinants of secondary debt market liquidity, identifying conditions under which trading in competitive markets results in sufficient ownership concentration to induce ex post efficient debt relief. The feasibility of debt relief is path-dependent, hinging upon interim economic conditions. Secondary debt markets are likely to freeze during recessions, precisely when trading has high social value. This is due to three factors: severe free-riding reduces profits of large bondholders; uninformed small bondholders are reluctant to sell due to high informational sensitivity of debt; and large investors are more likely to face wealth constraints. However, secondary markets need not freeze during recessions since high liquidity demand of uninformed bondholders increases their willingness to trade. Additionally, broader liquidity shocks during recessions increase the equilibrium stake held by large investors, promoting debt relief.

Keywords: Liquidity, Debt, Restructuring

JEL Classification: G33

Suggested Citation

Zechner, Josef and Hennessy, Christopher, Liquidity and Feasible Debt Relief (February 15, 2009). EFA 2009 Bergen Meetings Paper. Available at SSRN: or

Josef Zechner

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien A-1019

Christopher Hennessy (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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