Covenant-Driven Fire Sales

Shohini Kundu

No 22086, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Covenants mitigate agency frictions but can trigger asset sales at fire sale prices. I demonstrate covenant-driven fire sales and trace their real effects. Following a large negative oil-price shock, collateralized loan obligations exposed to oil-and-gas (O&G) firms approach their covenant thresholds and sell non-O&G loans, exerting price-pressure on non-O&G bonds and loans in primary and secondary markets. Affected non-O&G borrowers experience declines in financing, investment, R&D, and employment. Instrumenting CLO net loan sales with lenders’ O&G exposure, a one-percentage-point increase reduces firm investment by 0.08 percentage-points, 5% of mean investment. Covenant-induced liquidations can thus generate credit crunches via capital-market contagion.

Keywords: Covenants; Fire sales; Contracting frictions; Closed-end funds; Collateralized loan obligations (search for similar items in EconPapers)
JEL-codes: E44 G23 G32 (search for similar items in EconPapers)
Date: 2026-10
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