Liquidity and Feasible Debt Relief
45 Pages Posted: 20 Feb 2009
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: Suggested Citation