A Model of Endogenous Debt Maturity with Heterogeneous Beliefs

Matthew Darst and Ehraz Refayet
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Ehraz Refayet: Office of the Comptroller of the Currency, U.S. Treasury

No 1004, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies optimal debt maturity when firms issue non-contingent claims and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Multiple maturity issuances allow firms to best leverage scarce collateral by intertemporally catering risky promises to investors most willing to hold risk. Heterogeneous investors directly contrasts theories of debt predicated on agency costs and liquidity risk and provide a novel explanation for why large and mature companies typically issue debt with multiple maturities. Lastly, we show that non-financial covenants aimed at preventing debt dilution do not affect real outcomes because they simply reallocate collateral from short-term to long-term debt holders.

Date: 2018
New Economics Papers: this item is included in nep-ban
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Working Paper: A Model of Endogenous Debt Maturity with Heterogeneous Beliefs (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:1004

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