The role of financial markets in the unraveling of credit

We investigate how long an insolvent debtor can avoid default when survival benefits creditors collectively, but individual creditors gain from early repayment. Standard theory predicts that debt is not rolled over and default is immediate. Previous experimental studies of related environments suggest that liquidation is delayed, and we confirm that pattern here. We then study how secondary markets affect outcomes. The duration of the credit pool is unaffected, but average net payoffs increase because claims are held longer before redemption. With markets, realized payoff dispersion is significantly higher. Prices do not predict liquidation timing but correlate with realized payoffs.