Endogenous Seniority

Igor Livshits and Amartya Lahiri

No 1375, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: Seniority structure of debt has largely been ignored in both sovereign debt and consumer credit literature. Recent contributions on the subject have \emph{assumed} that older debt is necessarily senior. This paper studies the \emph{optimal} seniority structure of debt. In particular, we characterize a set of conditions under which borrowers do choose to sell senior debt first. We further point out when this result fails to arise as part of optimal seniority structure. If borrower faces shocks that are persistent, then debt pricing responds to these shocks making borrowing constraints particularly tight (debt particularly expensive) exactly when the need to borrow is at its peak. Thus, the borrower may want to issue junior debt in normal times, saving senior debt for a "rainy day." Thus, the endogenous pricing of debt generates a precautionary motive in the choice of seniority structure of debt.

Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:1375

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