Moral hazard and debt maturity

Gur Huberman and Rafael Repullo

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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: Short-term debt; long-term debt; optimal financial contracts; risk-shifting; rollover risk; inefficient liquidation. (search for similar items in EconPapers)
JEL-codes: G21 G32 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2014-06-13
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-cta and nep-mic
References: Add references at CitEc
Citations: View citations in EconPapers (6)

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http://eprints.lse.ac.uk/59294/ Open access version. (application/pdf)

Related works:
Working Paper: Moral Hazard and Debt Maturity (2014)
Working Paper: Moral Hazard and Debt Maturity (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:59294

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