Dynamic debt runs

Author / Creator

He, Zhiguo, 1977-

Available as

Online

Summary

We develop a dynamic model of debt runs on a firm, which invests in an illiquid asset by rolling over staggered short-term debt contracts. We derive a unique threshold equilibrium, in which credito...

We develop a dynamic model of debt runs on a firm, which invests in an illiquid asset by rolling over staggered short-term debt contracts. We derive a unique threshold equilibrium, in which creditors coordinate their asynchronous rollover decisions based on the firm's publicly observable and time-varying fundamental. Fear of the firm's future rollover risk motivates each maturing creditor to run ahead of others even when the firm is still solvent. Our model provides implications on the roles played by volatility, illiquidity and debt maturity in driving debt runs, as well as on firms' capital adequacy standards and credit risk.

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