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Rollover risk as market discipline: a two-sided inefficiency

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Abstract

Why does the market discipline that financial intermediaries face seem too weak during booms and too strong during crises? This paper shows in a general equilibrium setting that rollover risk as a disciplining device is effective only if all intermediaries face purely idiosyncratic risk. However, if assets are correlated, a two-sided inefficiency arises: Good aggregate states have intermediaries taking excessive risks, while bad aggregate states suffer from costly fire sales. The driving force behind this inefficiency is an amplifying feedback loop between asset values and market discipline. In equilibrium, financial intermediaries inefficiently amplify both positive and negative aggregate shocks.

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  • Thomas M. Eisenbach, 2013. "Rollover risk as market discipline: a two-sided inefficiency," Staff Reports 597, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:597
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    More about this item

    Keywords

    global games; fire sales; rollover risk; market discipline;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G01 - Financial Economics - - General - - - Financial Crises
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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