Staff Reports
Rollover Risk as Market Discipline: A Two-Sided Inefficiency
February 2013  Number 597
Revised May 2016
JEL classification: C73, D53, G01, G21, G24, G32

Author: Thomas M Eisenbach

Why does the market discipline that financial intermediaries face seem too weak during booms and too strong during crises? In a general equilibrium setting, this paper shows 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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