Moral Hazard and Debt Maturity

• Gur Huberman ^[1] ; Rafael Repullo ^[2]
  1. [1] Columbia Business School
  2. [2] CEMFI
• Localización: Documentos de Trabajo ( CEMFI ), Nº. 11 (CEMFI Working Paper 1311, December 2013), 2013
• Idioma: inglés
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• Resumen

  • We present a model of the maturity of a bank’s uninsured debt. The bank borrows funds and chooses afterwards the riskiness of its assets. This moral hazard problem leads to an excessive level of risk. Short-term debt may have a disciplining effect on the bank’s risk-shifting incentives, but it may lead to inefficient liquidation. We characterize the conditions under which short-term and long-term debt are feasible, and show circumstances under which only short-term debt is feasible and under which short-term debt dominates long-term debt when both are feasible. Thus, short-term debt may have the salutary effect of mitigating the moral hazard problem and inducing lower risk-taking. The results are consistent with key features of the common narrative of the period preceding the 2007-2009 financial crisis.