Fire-Sale Risk in the Leveraged Loan Market

103 Pages Posted: 17 Jul 2020 Last revised: 29 Nov 2021

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Yoshio Nozawa

University of Toronto

Date Written: November 25, 2021

Abstract

Using detailed loan holding data of Collateralized Loan Obligations (CLOs), we document empirical evidence for fire sale of leveraged loans due to leverage constraints on CLOs. Constrained CLOs are forced to sell loans downgraded to CCC or below, and thus loans widely held by constrained CLOs experience temporary price depreciation. This instability is exacerbated by diversification requirements. As the CLO market grows, each CLO's effort to diversify its portfolio leads to similarity in loan holdings among CLOs, and thus their leverage constraint binds simultaneously. CLOs' overlapping loan holdings spread idiosyncratic shocks to large borrowers to the overall leveraged loan market.

Keywords: Collateralized Loan Obligation, Fire sales, Leveraged loan, Shadow banking, Stress test, Systemic risk

JEL Classification: G12, G13

Suggested Citation

Elkamhi, Redouane and Nozawa, Yoshio, Fire-Sale Risk in the Leveraged Loan Market (November 25, 2021). Rotman School of Management Working Paper No. 3635086, Available at SSRN: https://ssrn.com/abstract=3635086 or http://dx.doi.org/10.2139/ssrn.3635086

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Yoshio Nozawa (Contact Author)

University of Toronto ( email )

105 St George St
Toronto, ON M5S3E6
Canada
3013125569 (Phone)

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