Rollover Risk and Credit Risk
This paper models a firm's rollover risk generated by conflict of interest between debt and equity holders. When the firm faces losses in rolling over its maturing debt, its equity holders are willing to absorb the losses only if the option value of keeping the firm alive justifies the cost of paying off the maturing debt. Our model shows that both deteriorating market liquidity and shorter debt maturity can exacerbate this externality and cause costly firm bankruptcy at higher fundamental thresholds. Our model provides implications on liquidity-spillover effects, the flight-to-quality phenomenon, and optimal debt maturity structures.
An earlier draft of this paper was circulated under the title "Liquidity and Short-term Debt Crises". We thank Long Chen, Douglas Diamond, Jennifer Huang, Erwan Morellec, Raghu Rajan, Andrew Robinson, Xing Zhou and seminar participants at Boston University, NBER Market Microstructure Meeting, Rutgers University, Swiss Finance Institute, Washington University, and University of Chicago for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Zhiguo He & Wei Xiong, 2012. "Rollover Risk and Credit Risk," Journal of Finance, American Finance Association, vol. 67(2), pages 391-430, 04. citation courtesy of