Konstantin Milbradt
Bio sketch: Konstantin Milbradt is an Assistant Professor of Finance at the MIT Sloan School of Management. His research interests are in financial economics, asset pricing, and financial intermediation. In particular, Professor Milbradt is interested in the impact of liquidity frictions and institutional frictions on financial markets. In recent work he has examined how marking-to-market and marking-to-model rules impact the investment and trading decisions of financial institutions.
Professor Milbradt holds a BA in economics from Oxford University and a PhD in economics from Princeton University.
Abstract: This paper studies the interaction between fundamental and liquidity for defaultable corporate bonds that are traded in an over-the-counter secondary market with search frictions. Bargaining with dealers determines a bond’s endogenous liquidity, which depends on both the firm fundamental and the time-to-maturity of the bond. Corporate default decisions interact with the endogenous secondary market liquidity via the rollover channel. A default-liquidity loop arises: Earlier endogenous default worsens a bond’s secondary market liquidity, which amplifies equity holders’ rollover losses, which in turn leads to earlier endogenous default. Thus, our model characterizes the full inter-dependence between liquidity premium and default premium in understanding credit spreads for corporate bonds. We also study the optimal maturity implied by the model, and an extension where worsening secondary market liquidity feeds back to endogenous under-investment.
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