Rollover Risk and Credit Risk
48 Pages Posted: 17 Sep 2009 Last revised: 9 Jun 2011
Date Written: June 7, 2011
Our model shows that deterioration of debt market liquidity not only leads to an increase in liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms' debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturing debt, equity holders bear the losses while maturing debt holders get paid in full. This conflict leads the firm to default at a higher fundamental threshold. Our model demonstrates an intricate interaction between liquidity premium and default premium and highlights the role of short-term debt in exacerbating rollover risk.
Keywords: Short-term Debt Crisis, Endogenous Default, Flight to Quality, Liquidity Spillover, Debt Maturity Structure
Suggested Citation: Suggested Citation