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By Douglas Gale, Tanju Yorulmazer, Sudipto Bhattacharya, Alberto Bisin, Patrick Bolton and Markus Brunnermeier


The debt capacity of an asset is the maximum amount that can be borrowed using the asset as collateral. We model a sudden collapse in the debt capacity of good collateral. We assume short-term debt that must be frequently rolled over, a small transaction cost of selling collateral in the event of default, and a small probability of meeting a buy-tohold investor. We then show that a small change in the asset's fundamental value can be associated with a catastrophic drop in the debt capacity, the kind of market freeze observed during the crisis of 2007 to 2008

Year: 2011
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