Fire-Sale Risk in the Leveraged Loan Market

73 Pages Posted: 17 Jul 2020 Last revised: 26 May 2022

See all articles by Redouane Elkamhi

Redouane Elkamhi

University of Toronto - Rotman School of Management

Yoshio Nozawa

University of Toronto

Date Written: May 26, 2022

Abstract

Using detailed loan holding data of Collateralized Loan Obligations (CLOs), we document empirical evidence for the 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 constraints simultaneously bind. 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 (May 26, 2022). Journal of Financial Economics (JFE), Forthcoming, 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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