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Rollover risk as market discipline: a two-sided inefficiency

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  • Thomas M. Eisenbach

Abstract

Why does the market discipline that banks face seem too weak during good times and too strong during bad times? This paper shows that using rollover risk as a disciplining device is effective only if all banks face purely idiosyncratic risk. However, if banks' assets are correlated, a two-sided inefficiency arises: Good aggregate states have banks taking excessive risks, while bad aggregate states suffer from fire sales. The driving force behind this inefficiency is an amplifying feedback loop between asset liquidation values and market discipline. This feedback loop operates in both good and bad aggregate states, but with opposite effects.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 597.

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Date of creation: 2013
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Handle: RePEc:fip:fednsr:597

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Related research

Keywords: Risk management ; Bank investments ; Risk assessment ; Financial markets;

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  1. Carlsson, Hans & van Damme, Eric, 1993. "Global Games and Equilibrium Selection," Econometrica, Econometric Society, vol. 61(5), pages 989-1018, September.
  2. Adam Copeland & Antoine Martin & Michael Walker, 2011. "Repo runs: evidence from the tri-party repo market," Staff Reports 506, Federal Reserve Bank of New York.
  3. Ing-Haw Cheng & Konstantin Milbradt, 2012. "The Hazards of Debt: Rollover Freezes, Incentives, and Bailouts," Review of Financial Studies, Society for Financial Studies, vol. 25(4), pages 1070-1110.
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