Leverage, Moral Hazard And Liquidity

Free registration required

Executive Summary

The authors 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 in the economy. This distribution of leverage, and its form as roll-over debt, is derived as endogenous outcomes with each firm's choice of leverage affecting the difficulty of other firms in rolling over debt in future.

  • Format: PDF
  • Size: 324.79 KB