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Managing Rollover Risk with Capital Structure Covenants in Structured Finance Vehicles

Sanjiv Ranjan Das and Seoyoung Kim
The Journal of Fixed Income Spring 2017, 26 (4) 92-112; DOI: https://doi.org/10.3905/jfi.2017.26.4.092
Sanjiv Ranjan Das
is a professor in the Leavey School of Business at Santa Clara University in Santa Clara, CA.
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  • For correspondence: srdas@scu.edu
Seoyoung Kim
is an assistant professor in the Leavey School of Business at Santa Clara University in Santa Clara, CA.
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  • For correspondence: srkim@scu.edu
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Abstract

The shadow banking system comprises special purpose vehicles (SPVs) characterized by high debt, illiquid long-maturity assets funded predominantly by short-maturity debt, and tranched liabilities, also known as the capital structure of the SPV. These three features lead to an adversarial game among senior-note holders, who solve for an optimal rollover policy based on the other senior tranches with varying rollover dates. This rollover policy is, in turn, taken into account by capital-note holders (i.e., investors in the equity tranche) when choosing the capital structure (i.e., the assets-to-debt ratio) of the SPV. Rollover risk increases in the number of time tranches, resulting in a lower equilibrium level of debt and higher cost of debt. The expected life of the SPV may also be shortened. We propose a covenant-based capital structure that mitigates these problems and is Pareto-improving for equity and debt holders in the SPV.

TOPICS: Fixed income and structured finance, volatility measures

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The Journal of Fixed Income: 26 (4)
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Managing Rollover Risk with Capital Structure Covenants in Structured Finance Vehicles
Sanjiv Ranjan Das, Seoyoung Kim
The Journal of Fixed Income Mar 2017, 26 (4) 92-112; DOI: 10.3905/jfi.2017.26.4.092

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Managing Rollover Risk with Capital Structure Covenants in Structured Finance Vehicles
Sanjiv Ranjan Das, Seoyoung Kim
The Journal of Fixed Income Mar 2017, 26 (4) 92-112; DOI: 10.3905/jfi.2017.26.4.092
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