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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/29544
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| Title: | Leverage, Moral Hazard and Liquidity |
| Authors: | Acharya, Viral
Viswanathan, S. |
| Issue Date: | 21-Jan-2010 |
| Series/Report no.: | FIN-09-036 |
| Abstract: | We consider a moral hazard setup wherein leveraged firms have incentives
to take on excessive risks and are thus rationed when they attempt to
roll over debt. Firms can sell assets to alleviate rationing. Liquidated
assets are purchased by non-rationed firms but their borrowing capacity
is also limited by the risk-taking moral hazard. The market-clearing
price exhibits cash-in-the-market pricing and depends on the entire
distribution of leverage (debt to be rolled over) in the economy. This
distribution of leverage, and its form as roll-over debt, are derived as
endogenous outcomes with eachfirm's choice of leverage affecting the
difficulty of otherfirms in rolling over debt in future. The model
provides an agency-theoretic linkage between market liquidity and
funding liquidity and formalizes the de-leveraging offinancial
institutions observed during crises. It also explains the role played by
system-wide leverage in generating deep discounts in prices when adverse
asset-quality shocks materialize in good times. |
| URI: | http://hdl.handle.net/2451/29544 |
| Appears in Collections: | Finance Working Papers
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