Rollover Risk and Market Freezes

Authors

  • VIRAL V. ACHARYA,

  • DOUGLAS GALE,

  • TANJU YORULMAZER

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    • Acharya is at NYU-Stern, CEPR, ECGI, and NBER; Gale is at the New York University; and Yorulmazer is at the Federal Reserve Bank of New York. The views expressed here are those of the authors and do not necessarily represent the views of the Federal Reserve Bank of New York or the Federal Reserve System. We are grateful to Dave Backus, Sudipto Bhattacharya, Alberto Bisin, Patrick Bolton, Markus Brunnermeier, John Geanakoplos, Ivalina Kalcheva, Todd Keister, Michael Manove, Martin Oehmke, Onur Ozgur, Matt Pritsker, Hyun Song Shin, S. “Vish” Viswanathan, Andrew Winton, and to all conference and seminar participants. Julia Dennett and Or Shachar provided excellent research assistance. All errors remain our own.


ABSTRACT

The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short-term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy-to-hold investor. We then show that a small change in the asset's fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008.

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