Rollover risk as market discipline: A two-sided inefficiency

Eisenbach, Thomas M.

doi:10.1016/j.jfineco.2017.07.009

Cited by 64 publications

(15 citation statements)

References 54 publications

(34 reference statements)

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“…Loans are costly to liquidate at the interim date and its liquidation value is

ψ \in (0, 1]

. This value is determined endogenously from a downward‐sloping demand for liquidated investment, as in Eisenbach (). For example, assets are relocated to a less‐productive sector (Shleifer and Vishny , Kiyotaki and Moore ).…”

Section: Modelmentioning

confidence: 99%

“…The most related papers are the global rollover games of Morris and Shin () and Eisenbach (). Building on the seminal work of Carlsson and van Damme () and Diamond and Dybvig (), Morris and Shin () solve for the unique equilibrium in a bank run game, using global games techniques .…”

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confidence: 99%

“…Extending the analysis to multiple intermediaries and fire sales, I explore macroprudential regulation of liquidity. Eisenbach () also analyzes an ex post coordination game in which investors roll over short‐term debt. He studies the ex ante optimal maturity choice of funding to discipline a bank manager tempted by moral hazard and derives a two‐sided inefficiency.…”

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confidence: 99%

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Rollover Risk, Liquidity and Macroprudential Regulation

Ahnert¹

2016

J of Money Credit Banking

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Non-technical summaryThe stability of the financial system is a key concern to central bankers. A particular aspect that has received much attention recently is the wholesale funding of banks. Before the financial crisis, banks funded themselves increasingly with short-term debt. However, such funding dried up as economic news deteriorated. This dark side of wholesale funding in part inspired the Basel III regulation.Specifically, a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR) require banks to maintain a minimum level of liquidity.In this paper, I study rollover risk in wholesale funding markets. Investors may roll over funding to their intermediaries after receiving some noisy information about their solvency. My setup has two noteworthy features. First, financial intermediaries are allowed to hold precautionary liquidity in order to prepare for the possible future drying up of funding. That is, intermediaries choose how much liquidity to hold initially, while the remainder is invested in illiquid projects with high expected returns. Second, a fire sale occurs when intermediaries liquidate their projects jointly.This paper derives two results. The first is technical and states that the methods previously used to ensure a unique equilibrium require refinement. Uniqueness matters, since it puts subsequent policy implications on a strong theoretical footing. The second result is the inefficiency of private liquidity holdings. Since intermediaries free ride on the liquidity holdings of other intermediaries, there is excessive liquidation. By contrast, a macroprudential authority understands the systemic nature of liquidity, whereby one intermediary's holdings mitigate the risk of fire sales for other intermediaries. Imposing a macroprudential liquidity buffer restores efficiency.Finally, I link this welfare result to the regulatory debate of Basel III. I argue why this set-up provides a theoretical foundation for the Liquidity Coverage Ratio. It follows a brief discussion about requiring intermediaries to hold additional liquidity versus creating a systemic liquidity fund that all intermediaries contribute to. While the proposed set-up also provides some support for the Net Stable Funding Ratio, I describe how the current set-up could be extended to address the trade-offs associated with the NSFR more directly.2

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“…Loans are costly to liquidate at the interim date and its liquidation value is

ψ \in (0, 1]

Section: Modelmentioning

confidence: 99%

mentioning

confidence: 99%

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confidence: 99%

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Rollover Risk, Liquidity and Macroprudential Regulation

Ahnert¹

2016

J of Money Credit Banking

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“…5 Early works in this literature study runs on a single bank and take the interim liquidation value (function) of the bank as exogenous (e.g., Rochet and Vives (2004), Goldstein and Pauzner (2005), and the general model of Vives (2014a)). Liu (2016) and Eisenbach (2017) recently made progress in endogenizing the interim liquidation values by studying many banks with interactions in a common asset market. 6 Our paper contributes to this literature in (i) building a tractable framework to endogenize liquidation values in the financial system context, featuring both fire sales to outside investors and interbank trading, which is important for explaining empirical evidence and policy analysis, and (ii) modeling systemic bank runs in a general setting without and with aggregate uncertainty.…”

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confidence: 99%

“…A new paper by Goldstein et al (2020) presents a global-games model to study bank heterogeneity and financial stability by emphasizing reinforcement of two complementarities. Their model also uses a setting in which runs on banks are connected because of fire sales in a common asset market, which is closely related to Liu (2016Liu ( , 2018aLiu ( , 2018b, Eisenbach (2017), and our work. Their paper considers aggregate uncertainty and uses an information structure to have a unique equilibrium.…”

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confidence: 99%

A Model of Systemic Bank Runs

LIU¹

2023

The Journal of Finance

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We develop a tractable model of systemic bank runs. The market‐based banking system features a two‐layer structure: banks with heterogeneous fundamentals face potential runs by their creditors while they trade short‐term funding in the asset (interbank) market in response to creditor withdrawals. The possibility of a run on a particular bank depends on its assets' interim liquidation value, and this value depends endogenously in turn on the status of other banks in the asset market. The within‐bank coordination problem among creditors and the cross‐bank price externality feed into each other. A small shock can be amplified into a systemic crisis.

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Does the firm's life cycle matter in the relationship between short‐term debt and investment efficiency?

Abuhommous

2024

Int. J Fin Econ

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In this paper, we investigate the role of short‐term debt in investment efficiency, and we examine the impact of the firm's life cycle stages on this relationship. Using data from non‐financial companies in the United States from 1971 to 2021, we argue that the short‐term debt may reduce the information asymmetries and discipline the management decisions, thus improving the investment efficiency. We argue, however, that the relationship varies throughout different life cycle stages. We find that short‐term debt positively influences investment efficiency and over‐investment. Furthermore, the firm's life cycle significantly impacts investment efficiency, with the introduction and growth stages negatively associated with it. The life cycle also affects the relationship between short‐term debt and investment efficiency, particularly during the growth stage. These results emphasis the role of short‐term debt and the firm's life cycle in mitigating information asymmetries and shaping management behaviour.

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Rollover risk as market discipline: A two-sided inefficiency

Cited by 64 publications

References 54 publications

Rollover Risk, Liquidity and Macroprudential Regulation

Rollover Risk, Liquidity and Macroprudential Regulation

A Model of Systemic Bank Runs

Does the firm's life cycle matter in the relationship between short‐term debt and investment efficiency?

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