TY - JOUR AU - Acharya,Viral V. AU - Gale,Douglas AU - Yorulmazer,Tanju TI - Rollover Risk and Market Freezes JF - National Bureau of Economic Research Working Paper Series VL - No. 15674 PY - 2010 Y2 - January 2010 UR - http://www.nber.org/papers/w15674 L1 - http://www.nber.org/papers/w15674.pdf N1 - Author contact info: Viral V. Acharya Stern School of Business New York University 44 West 4th Street, Suite 9-84 New York, NY 10012 Tel: 212/998-0354 Fax: 212 995 4233 E-Mail: vacharya@stern.nyu.edu Douglas Gale Department of Economics New York University 19 W. 4th Street, 6th Floor New York, NY 10012 E-Mail: douglas.gale@nyu.edu Tanju Yorulmazer Federal Reserve Bank of New York 33 Liberty Street New York, NY 10045 Tel: 212 720 6887 E-Mail: tanju.yorulmazer@ny.frb.org AB - The crisis of 2007-09 has been characterized by a sudden freeze in the market for short-term, secured borrowing. We present a model that can explain a sudden collapse in the amount that can be borrowed against finitely-lived assets with little credit risk. The borrowing in this model takes the form of a repurchase agreement ("repo") or asset-backed commercial paper that has to be rolled over several times before the underlying assets mature and their true value is revealed. In the event of default, the creditors can seize the collateral. We assume that there is a small cost of liquidating the assets. The debt capacity of the assets (the maximum amount that can be borrowed using the assets as collateral) depends on the information state of the economy. At each date, in general there is either "good news" (the information state improves), "bad news" (the information state gets worse), or "no news" (the information state remains the same). When rollover risk is high, because debt must be rolled over frequently, we show that the debt capacity is lower than the fundamental value of the asset and in extreme cases may be close to zero. This is true even if the fundamental value of the assets is high in all states. Thus, a small change in information, as measured by a change in the fundamental value, can lead to a "market freeze." Interpreted differently, the model explains why discounts in overnight repo borrowing, the so-called "haircuts," rose dramatically during the crisis for asset-backed securities with low credit risk once bad news about the underlying cash flows arrived. ER -