A Model of Endogenous Debt Maturity with Heterogeneous Beliefs

This paper studies how investor heterogeneity determines equilibrium debt maturity in a model with default. The traditional representative investor assumption is a special case where a weak form of the Modigliani-Miller theorem holds; allocations with either all long- or all short-term debt are equivalent and dominate any interior combination of the two. By contrast, in the general heterogeneous investor setting, debt maturity always matters. A maturity strategy that combines long- and short-term debt is always optimal and dominates either corner solution. Thus, the model highlights the importance of supply frictions in determining equilibrium issuance strategies and is consistent with numerous empirical findings