Rollover Risk and Market Freezes

56 Pages Posted: 18 Feb 2009

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Douglas M. Gale

New York University (NYU) - Department of Economics

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB)

Multiple version iconThere are 4 versions of this paper

Date Written: January 2009

Abstract

We consider the debt capacity of a risky asset when debt is being rolled over and there is a liquidation cost in case of default. We show that debt capacity depends on how information about the quality of the asset is revealed. When the information structure is based on "optimistic" expectations, the arrival of no news about the asset is good news; under this structure, debt capacity does not depend upon rollovers and liquidation cost, and is simply equal to expected cash flows from the asset. In contrast, when the information structure is based on "pessimistic" expectations, no news about the asset is bad news; under this structure, debt capacity of the asset is decreasing in the liquidation cost and frequency of rollovers. In the limit, as the number of rollovers becomes unbounded, the debt capacity goes to zero even for an arbitrarily small default risk. Our model explains why markets for rollover debt, such as asset-backed commercial paper, may experience sudden freezes. The model also provides an explicit formula for the haircut in secured borrowing or repo transactions.

Keywords: asset-backed commercial paper, credit risk, haircut, liquidation cost, repo, secured borrowing

JEL Classification: D8, G12, G21, G24, G32, G33

Suggested Citation

Acharya, Viral V. and Gale, Douglas M. and Yorulmazer, Tanju, Rollover Risk and Market Freezes (January 2009). CEPR Discussion Paper No. DP7122. Available at SSRN: https://ssrn.com/abstract=1345648

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Douglas M. Gale

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

Tanju Yorulmazer

University of Amsterdam - Faculty of Economics and Business (FEB) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

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