Abstract
Using detailed loan holding data of Collateralized Loan Obligations (CLOs), we document empirical evidence for systemic risk due to leverage constraints on CLOs. Constrained CLOs fire sell loans downgraded to CCC or below, and thus loans widely held by constrained CLOs experience temporarily lower prices. This instability is exacerbated over time. As the CLO market grows, each CLO's effort to diversify its portfolio leads to similarity in loan holdings among CLOs, such that their leverage constraint binds simultaneously. CLOs' overlapping loan holdings transform idiosyncratic credit risk of large borrowers to systemic risk in the leveraged loan market.
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