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Only Paul Could Go To Changchun

The Flight from Maturity

3/9/2017

 
Here.

Why did the failure of Lehman Brothers make the financial crisis dramatically worse? The financial crisis was a process of a build-up of risk during the crisis prior to the Lehman failure. During the crisis market participants tried to preserve an option to withdraw by shortening maturities --- the “flight from maturity”. This flight from maturity was manifested in a steepening of the term structures of spreads in money markets. With increasingly short maturities, lenders created the possibility of fast exit. The failure of Lehman Brothers was the tipping point of this build-up of systemic fragility. “Tail risk” is endogenous.

In this paper, we show that this maturity shortening not only occurred for Lehman, but was a general phenomenon of the crisis, affecting all large financial firms and all money market instruments. This means that fragility built up during the crisis, so that an enormous amount of debt became overnight debt, a hair trigger or exit option for lenders. This systemic risk was endogenous. The Lehman failure was the result. 

From:

Gary Gorton
Andrew Metrick
Yale School of Management



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