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The externalities of fire sales: evidence from collateralized loan obligations

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  • Kundu, Shohini

Abstract

This paper investigates how covenants, intrinsic to Collateralized Loan Obligation (CLO) indentures, may amplify idiosyncratic shocks, imposing negative externalities on unrelated firms in CLO portfo-lios. Following a negative shock to the oil & gas industry, CLOs with exposure to oil and gas loans are pushed closer to their covenant thresholds and fire-sell unrelated loans in the secondary loan market to alleviate these constraints. These fire sales exert price pressure on the securities of unrelated firms, creating market dislocations. The erosion in the liquidity positions of exposed firms spills over into real economic activity. The findings highlight the real effects from fire sales arising due to contracting frictions. JEL Classification: E44, G23, E32

Suggested Citation

  • Kundu, Shohini, 2023. "The externalities of fire sales: evidence from collateralized loan obligations," ESRB Working Paper Series 141, European Systemic Risk Board.
    • Handle: RePEc:srk:srkwps:2023141
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    More about this item

    Keywords

    CLOs; closed-end funds; contracting frictions; covenants; externalities; fire sales;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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