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A Model of Endogenous Debt Maturity with Heterogeneous Beliefs

Author

Listed:
  • Matthew Darst

    (Board of Governors of the Federal Reserv)

  • Ehraz Refayet

    (Office of the Comptroller of the Currency, U.S. Treasury)

Abstract

This paper studies optimal debt maturity when firms issue non-contingent claims and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Multiple maturity issuances allow firms to best leverage scarce collateral by intertemporally catering risky promises to investors most willing to hold risk. Heterogeneous investors directly contrasts theories of debt predicated on agency costs and liquidity risk and provide a novel explanation for why large and mature companies typically issue debt with multiple maturities. Lastly, we show that non-financial covenants aimed at preventing debt dilution do not affect real outcomes because they simply reallocate collateral from short-term to long-term debt holders.

Suggested Citation

  • Matthew Darst & Ehraz Refayet, 2018. "A Model of Endogenous Debt Maturity with Heterogeneous Beliefs," 2018 Meeting Papers 1004, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:1004
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    References listed on IDEAS

    as
    1. Douglas W. Diamond & Zhiguo He, 2014. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," Journal of Finance, American Finance Association, vol. 69(2), pages 719-762, April.
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    Cited by:

    1. Caglio, Cecilia & Darst, R. Matthew & Parolin, Eric, 2019. "Half-full or half-empty? Financial institutions, CDS use, and corporate credit risk," Journal of Financial Intermediation, Elsevier, vol. 40(C).
    2. Şebnem Kalemli-Özcan & Luc Laeven & David Moreno, 2022. "Debt Overhang, Rollover Risk, and Corporate Investment: Evidence from the European Crisis," Journal of the European Economic Association, European Economic Association, vol. 20(6), pages 2353-2395.

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    More about this item

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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