Moral hazard and debt maturity

Huberman, Gur and Repullo, Rafael (2014) Moral hazard and debt maturity. Systemic Risk Centre Discussion Papers (13). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

We present a model of the maturity of a bank’s uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank’s risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://www.systemicrisk.ac.uk/
Additional Information:	© 2014 The Authors
Divisions:	Systemic Risk Centre
Subjects:	H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
Date Deposited:	29 Aug 2014 11:12
Last Modified:	13 Sep 2024 20:27
Projects:	ES/K002309/1, ECO2011-26308
Funders:	Economic and Social Research Council, FDIC Center for Financial Research and the Spanish Ministry of Science and Innovation
URI:	http://eprints.lse.ac.uk/id/eprint/59294

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