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Rollover Risk and Credit Risk




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    • He is with the University of Chicago, and Xiong is with Princeton University and NBER. An earlier draft of this paper was circulated under the title “Liquidity and Short-Term Debt Crises.” We thank Franklin Allen, Jennie Bai, Long Chen, Douglas Diamond, James Dow, Jennifer Huang, Erwan Morellec, Martin Oehmke, Raghu Rajan, Andrew Robinson, Alp Simsek, Hong Kee Sul, S. Viswanathan, Xing Zhou, and seminar participants at Arizona State University, Bank of Portugal Conference on Financial Intermediation, Boston University, Federal Reserve Bank of New York, Indiana University, NBER Market Microstructure Meeting, NYU Five Star Conference, 3rd Paul Woolley Conference on Capital Market Dysfunctionality at London School of Economics, Rutgers University, Swiss Finance Institute, Temple University, Washington University, 2010 Western Finance Association Meetings, University of British Columbia, University of California–Berkeley, University of Chicago, University of Oxford, and University of Wisconsin at Madison for helpful comments. We are especially grateful to Campbell Harvey, an anonymous associate editor, and an anonymous referee for extensive and constructive suggestions.


Our model shows that deterioration in debt market liquidity leads to an increase in not only the liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms' debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturing debt, equity holders bear the losses while maturing debt holders are paid in full. This conflict leads the firm to default at a higher fundamental threshold. Our model demonstrates an intricate interaction between the liquidity premium and default premium and highlights the role of short-term debt in exacerbating rollover risk.