Moral Hazard and Debt Maturity

Rafael Repullo and Gur Huberman

No 9930, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We present a model of the maturity of a bank's uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank's risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.

Keywords: Inefficient liquidation; Long-term debt; Optimal financial contracts; Risk-shifting; Rollover risk; Short-term debt (search for similar items in EconPapers)
JEL-codes: G21 G32 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-ban and nep-cta
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Citations: View citations in EconPapers (7)

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Related works:
Journal Article: Moral hazard and debt maturity (2025)
Working Paper: Moral hazard and debt maturity (2014)
Working Paper: Moral Hazard and Debt Maturity (2013)
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