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Asymmetric Information and Roll-Over Risk

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  • Philipp König
  • David Pothier

Abstract

How do banks choose their debt maturity structure when credit markets are subject to information frictions? This paper proposes a model of equilibrium maturity choice with asymmetric information and endogenous roll-over risk. We show that in the presence of public signals about firms' creditworthiness (credit ratings), firms choose to expose themselves to positive roll-over risk in order to minimize price distortions. Short-term financing is socially desirable when banks' capacity to repay short-term creditors depends on their credit rating, as it helps mitigate the underlying adverse selection problem. Notwithstanding these social benefits, the equilibrium maturity structure always exhibits inefficient short-termism. If banks receiving a credit downgrade face sufficiently high roll-over risk, the equilibrium maturity structure approaches the constrained efficient allocation.

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Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1364.

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Length: 34 p.
Date of creation: 2014
Date of revision:
Handle: RePEc:diw:diwwpp:dp1364

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Keywords: Debt maturity; rollover risk; asymmetric information; global games;

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