The Maturity Rat Race

Abstract

Why do some firms, especially financial institutions, finance themselves so short‐term? We show that extreme reliance on short‐term financing may be the outcome of a maturity rat race: a borrower may have an incentive to shorten the maturity of an individual creditor's debt contract because this dilutes other creditors. In response, other creditors opt for shorter maturity contracts as well. This dynamic toward short maturities is present whenever interim information is mostly about the probability of default rather than the recovery in default. For borrowers that cannot commit to a maturity structure, equilibrium financing is inefficiently short‐term.

Impact of New Debt Offerings on Existing Corporate Bondholders

“…This evidence supports the prediction of adverse consequences for existing bondholders when new bonds have a shorter maturity. This finding is consistent with the literature on the consequences of maturity shortening by Acharya, Gale, and Yorulmazer (), Brunnermeier and Oehmke (), He and Xiong (), and others we cite previously.…”

“…That is, firms tend to issue more long‐term debt when the government funds itself with short‐term debt. Brunnermeier and Oehmke () show that a borrower may have an incentive to shorten the maturity of an individual creditor's debt contract because this dilutes other creditors. They call this effect the maturity rat race.…”

“…Denis and Wang () find that restrictions in private debt covenants are sometimes relaxed in response to operating conditions. Brunnermeier and Oehmke () note that unmonitored covenants are even worse than having no covenant at all.…”

Originators, Traders, Neutrals, and Traditioners Various Banking Business Models Across the Globe: Does the Business Model Matter for Financial Stability?

“…The existing literature shows that source of funding determines the liquidity problems of banks, and thus the riskiness of banks (Shleifer and Vishny, 2010;Brunnermeier and Pedersen, 2007;Brunnermeier and Oehmke, 2013). Thus, we include liquidity ratio defined as liquid asset to deposit and short-term funding.…”

“…First, the maturity and type of banks' funding sources, and second the correlation between the nature of bank'sasset and its source of funds. Demirgüç-Kunt and Huizinga (2010)document that banks, which fund their activities by non-deposit funds are more risky, however Allen et al (2012), Brunnermeier and Oehmke (2013)indicate that especially banks, which used in their funding structure repo instruments suffered during the crisis at most. Also, the link between the nature of the asset and bank's liability source is important.…”