Rollover Traps
55 Pages Posted: 7 Mar 2016 Last revised: 6 Dec 2016
Date Written: October 25, 2016
Abstract
We model the joint effects of debt maturity and cash holdings on default risk. When firms have short-term debt outstanding, negative cash flow shocks lead to a drop in liquid reserves and may cause firms to suffer losses when rolling over their debt, due to weaker fundamentals. This mechanism gets more pronounced as debt maturity decreases, increases default risk, and can give rise to a rollover trap, a scenario in which firms burn their cash flows and cash reserves due to severe rollover losses. High exposure to rollover risk can also make claimholders risk-loving and lead distressed firms to implement gambling strategies.
Keywords: Short-term debt financing; rollover risk; financial amplification
JEL Classification: G32, G35
Suggested Citation: Suggested Citation