A Model of Endogenous Debt Maturity with Heterogeneous Beliefs

Matthew Darst and Ehraz Refayet ()
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Ehraz Refayet: https://www.occ.gov/about/who-we-are/organizations/economics-department/meet-the-research-economists/bio-ehraz-refayet.html

No 2017-057, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: This paper studies optimal debt maturity in an economy with repayment enforcement frictions and investors disagree about repayment probabilities. The optimal debt maturity choice is a mix of long- and short-term debt securities. Spreading risky debt claims on cash flows over time allows debt to be priced by investors most willing to hold risk at each point in time, thereby increasing investment and output. By contrast, a single maturity, either all long- or short-term, will be priced by investors less willing to hold risk, which reduces investment and output. The model provides a novel explanation for the stylized fact that large and mature companies almost always issue debt with multiple maturities rather than a single maturity, and is broadly consistent with empirical debt maturity results. Lastly, we show that non-financial covenants that prevent debt dilution only serve as substitutes for short-term debt and do not affect real outcomes as they do not allow the firm to create additional collateral against which to borrow.

Keywords: Collateral; Cost of capital; Debt covenants; Debt maturity; Investment (search for similar items in EconPapers)
JEL-codes: D92 E22 G11 G12 G31 G32 (search for similar items in EconPapers)
Pages: 54 pages
Date: 2017-05
New Economics Papers: this item is included in nep-dcm and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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https://www.federalreserve.gov/econres/feds/files/2017057pap.pdf (Original) (application/pdf)

Related works:
Working Paper: A Model of Endogenous Debt Maturity with Heterogeneous Beliefs (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2017-57

DOI: 10.17016/FEDS.2017.057r1

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