Rollover Risk and Credit Spreads: Evidence from International Corporate Bonds *

Abstract

Using a new dataset on corporate bonds placed in international markets by emerging and developed borrowers, this article demonstrates that a high proportion of short-term debt exacerbates the effect of debt market illiquidity on corporate bond spreads. This effect is present during both periods of financial stability and of financial distress, and it is smaller in the banking sector than in other sectors. The article's major finding is robust when controlling for potential endogeneity. Moreover, the results are consistent with the predictions of structural credit risk models that argue that a higher proportion of short-term debt increases a firm's exposure to debt market illiquidity through a "rollover risk" channel.

Effect of rollover risk on default risk: Evidence from bank financing

“…Moreover, crises in credit market boost the effect. 2 In contrast, we do not find significant evidence of this rollover risk effect 1 To the best of our knowledge, only two published articles (Gopalan, Song, and Yerramilli, 2014;Valenzuela, 2015) document that firms that experience large increases in rollover risk are likely to suffer a strong deterioration in their credit quality. The work of Chen, Xu, and Yang (2012) and Hu (2010) also relates to this topic.…”

“…This maturity effect on credit spreads is more pronounced for firms with high leverage or high systematic risk. Valenzuela (2015) finds that debt market illiquidity increases firms' corporate bond spreads through rollover risk in the international context. Our first hypothesis follows directly from these theoretical predictions and empirical evidence.…”

“…20 It is well known that spreads contain default premiums (e.g., Valenzuela, 2015 1990, 1991, 2001, 2002, 2008, and 2009. Given that credit market conditions are likely to be related to economic conditions, the literature also uses recessions to proxy for distressed credit markets (e.g., Valenzuela, 2015) To examine this theoretical prediction, we add the interaction term (LT)-1 ,t-1 x Baa-Aaa Spread in the baseline regression.…”

“…Given that credit market conditions are likely to be related to economic conditions, the literature also uses recessions to proxy for distressed credit markets (e.g., Valenzuela, 2015) To examine this theoretical prediction, we add the interaction term (LT)-1 ,t-1 x Baa-Aaa Spread in the baseline regression. Given that the market condition variable only fluctuates over time, we cannot simultaneously control for market conditions and year dummies.…”

Endogenous Debt Maturity and Rollover Risk

“…It is therefore incorrect to claim that short-term debt is a cause of fragility, as both maturity shortening and credit market access are causally determined by market expectations about the bank's future performance. 3 Importantly, if one believes that short-term debt is the source of instability it would be optimal to impose restrictions on the use of such an instrument; however, this recommendation could even further destabilize weak 1 See Diamond and Dybvig (1983), Brunnermeier (2009), Krishnamurthy (2010) and He and Xiong (2012c), Gopalan et al (2014) and Valenzuela (2015).…”