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Asymmetric Information and Roll-over Risk

  • Philipp König
  • David Pothier

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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  1. Stephen Morris & Hyun Song Shin, 2001. "Coordination risk and the price of debt," LSE Research Online Documents on Economics 25046, London School of Economics and Political Science, LSE Library.
  2. Markus K. Brunnermeier & Martin Oehmke, 2013. "The Maturity Rat Race," Journal of Finance, American Finance Association, vol. 68(2), pages 483-521, 04.
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  12. Hyun Song Shin, 2009. "Reflections on Northern Rock: The Bank Run That Heralded the Global Financial Crisis," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 101-19, Winter.
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  14. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
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  19. Thomas M. Eisenbach, 2013. "Rollover risk as market discipline: a two-sided inefficiency," Staff Reports 597, Federal Reserve Bank of New York.
  20. repec:oup:qjecon:v:106:y:1991:i:3:p:709-37 is not listed on IDEAS
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