This paper explores, in a multiperiod setting, the funding liquidity of a borrower that finances its operations through short-term debt. The short-term debt is provided by a continuum of creditors with heterogeneous beliefs about the prospects of the borrower. In each period, creditors observe the borrower's fundamentals and decide on the amount they invest in its short-term debt. We formalize this problem as a coordination game, and we show that there exists a unique reasonable Nash equilibrium. We show that the borrower is able to refinance if and only if the liquid net worth is above an illiquidity barrier, and we explicitly find this barrier in terms of the distribution of capital and beliefs across creditors.Keywords Liquidity risk · Credit risk · Nash equilibrium · Bank run Mathematics Subject Classification 91A10 · 91A13 · 91A20 · 91A80 · 91B69 · 91B70 JEL Classification C72 · C73 · D53 · D81 · G11 B A. Minca acm299@cornell.edu A. Krishenik
This paper explores a one‐period model for a firm that finances its operations through debt provided by heterogeneous creditors. Creditors differ in their beliefs about the firm's investment outcomes. We show the existence of Stackelberg equilibria in which the firm holds cash reserves in order to provide incentives for pessimistic creditors to invest in the firm. We find interest rates and cash holdings to be complementary tools for increasing debt capacity. In markets with a high concentration of capital across a small interval of pessimistic creditors or by a few large creditors, cash holdings is the preferred tool to increase the debt capacity of the firm.
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