Moral Hazard and Debt Maturity

48 Pages Posted: 2 Jun 2014

See all articles by Gur Huberman

Gur Huberman

Columbia Business School - Finance and Economics

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: April 2014

Abstract

We present a model of the maturity of a bank's uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank's risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.

Keywords: Inefficient liquidation, Long-term debt, Optimal financial contracts, Risk-shifting, Rollover risk, Short-term debt

JEL Classification: G21, G32

Suggested Citation

Huberman, Gur and Repullo, Rafael, Moral Hazard and Debt Maturity (April 2014). CEPR Discussion Paper No. DP9930. Available at SSRN: https://ssrn.com/abstract=2444953

Gur Huberman (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91429 0551 (Phone)
+34 91429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~repullo/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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