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Federal Reserve Bank of New York
Staff Reports
Rollover risk as market discipline: a two-sided inefficiency
Thomas M. Eisenbach
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, Rollover risk as market discipline: a two-sided inefficiency, Federal Reserve Bank of New York, Staff Reports 597, 2013, revised 01 Oct 2016.
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Keywords: rollover risk; market discipline; fire sales; global games
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