Fire-Sale Risk in the Leveraged Loan Market
73 Pages Posted: 17 Jul 2020 Last revised: 26 May 2022
Date Written: May 26, 2022
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: Suggested Citation