Abstract
Financial institutions constitute an increasingly important cornerstone of capital markets, yet research at the intersection of asset management contracts and asset pricing is sparse. In this paper, I study the externalities of Collateralized Loan Obligation (CLO) contracts on asset prices. The trading behavior of CLO managers generates price pressure for distressed loans around bankruptcy defaults, introducing fire sale risk. This behavior is driven mainly by covenant considerations. CLOs operating closest to their capital constraints experience significantly lower cumulative returns relative to unconstrained CLOs. Hence, this work demonstrates how CLO covenants interact with managerial incentives in the provision of credit.
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