Rollover Risk and Market Freezes

44 Pages Posted: 25 Jan 2010

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 2010

Abstract

The crisis of 2007-09 has been characterized by a sudden freeze in the market for short-term, secured borrowing. We present a model that can explain a sudden collapse in the amount that can be borrowed against finitely-lived assets with little credit risk. The borrowing in this model takes the form of a repurchase agreement ("repo") or asset-backed commercial paper that has to be rolled over several times before the underlying assets mature and their true value is revealed. In the event of default, the creditors can seize the collateral. We assume that there is a small cost of liquidating the assets. The debt capacity of the assets (the maximum amount that can be borrowed using the assets as collateral) depends on the information state of the economy. At each date, in general there is either "good news" (the information state improves), "bad news" (the information state gets worse), or "no news" (the information state remains the same). When rollover risk is high, because debt must be rolled over frequently, we show that the debt capacity is lower than the fundamental value of the asset and in extreme cases may be close to zero. This is true even if the fundamental value of the assets is high in all states. Thus, a small change in information, as measured by a change in the fundamental value, can lead to a "market freeze." Interpreted differently, the model explains why discounts in overnight repo borrowing, the so-called "haircuts," rose dramatically during the crisis for asset-backed securities with low credit risk once bad news about the underlying cash flows arrived.

Suggested Citation

Acharya, Viral V. and Gale, Douglas M. and Yorulmazer, Tanju, Rollover Risk and Market Freezes (January 2010). NBER Working Paper No. w15674. Available at SSRN: https://ssrn.com/abstract=1540959

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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