We provide evidence that lenders differ in their ex post incentives to internalize price‐default externalities associated with the liquidation of collateralized debt. Using the mortgage market as a laboratory, we conjecture that lenders with a large share of outstanding mortgages on their balance sheets internalize the negative spillovers associated with the liquidation of defaulting mortgages and thus are less inclined to foreclose. We provide evidence consistent with our conjecture. Arguably as a consequence, zip codes with a higher concentration of outstanding mortgages experience smaller house prices declines. These results are not driven by unobservable zip code or lender characteristics.

We show that the prospect of a debt renegotiation favorable to shareholders reduces the firm's equity risk. Equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for firms with more shareholder bargaining power relative to debt holders. These relations weaken as the country's insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, equity risk is independent of shareholders' incentives to default strategically. We argue that these findings support the hypothesis that the threat of strategic default can reduce the firm's equity risk.