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Debt Maturity Structure and Liquidity Risk

Douglas W. Diamond
The Quarterly Journal of Economics
Vol. 106, No. 3 (Aug., 1991), pp. 709-737
Published by: Oxford University Press
Stable URL: http://www.jstor.org/stable/2937924
Page Count: 29
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Debt Maturity Structure and Liquidity Risk
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Abstract

This paper analyzes debt maturity structure for borrowers with private information about their future credit rating. Borrowers' projects provide them with rents that they cannot assign to lenders. The optimal maturity structure trades off a preference for short maturity due to expecting their credit rating to improve, against liquidity risk. Liquidity risk is the risk that a borrower will lose the nonassignable rents due to excessive liquidation incentives of lenders. Borrowers with high credit ratings prefer short-term debt, and those with somewhat lower ratings prefer long-term debt. Still lower rated borrowers can issue only short-term debt.

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