Report

Rollover risk as market discipline: a two-sided inefficiency

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.

Keywords: global games; fire sales; rollover risk; market discipline;

JEL Classification: G21; G32; G24; D53; G01; C73;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2016-05-01

Number: 597

Pages: 47 pages