Skip to main content

Please enter a keyword and click the arrow to search the site

Moral Hazard, Collateral and Liquidity



Publishing details

Authors / Editors

Acharya V V;Viswanathan S

Publication Year



We consider a moral hazard setup wherein leveraged firms have incentives to take on excessive risks and are thus rationed when they attempt to roll over debt. Firms can optimally pledge cash as collateral to reduce rationing, but in the process must liquidate some of their assets. Liquidated assets are purchased by non-rationed firms but their borrowing capacity is also limited by the risktaking moral hazard. The market-clearing price exhibits cash-in-the-market pricing and depends on the entire distribution of leverage (debt to be rolled over) in the economy. This distribution of leverage, and indeed its very form as roll-over debt, are derived as endogenous outcomes with each firm’s choice of leverage anticipating the difficulty for all firms in rolling over debt in future. The model provides a natural linkage between market liquidity and funding liquidity, shows that optimally designed collateral requirements have a stabilizing effect on prices, and illustrates the possible role of leverage in generating deep discounts in prices when adverse asset-quality shocks materialize in good times.


leverage; risk-shifting; credit rationing; market liquidity; funding liquidity, fire sales,

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 474


IFA Working Paper

Available on ECCH


Select up to 4 programmes to compare

Select one more to compare
subscribe_image_desktop 5949B9BFE33243D782D1C7A17E3345D0

Sign up to receive our latest news and business thinking direct to your inbox


Sign up to receive our latest course information and business thinking

Leave your details above if you would like to receive emails containing the latest thought leadership, invitations to events and news about courses that could enhance your career. If you would prefer not to receive our emails, you can still access the case study by clicking the button below. You can opt-out of receiving our emails at any time by visiting: or by unsubscribing through the link provided in our emails. View our Privacy Policy for more information on your rights.