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Real option with liquidity constraints under secondary debt illiquidity risk market

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  • Xu, Qing
  • Yang, Jinqiang

Abstract

We incorporate the illiquidity risk subjects to the secondary debt markets into the real option framework with liquidity financing constraints. Our model shows that the investment threshold and optimal leverage no longer monotonically increase in project risk but are up to internal liquidity, and illiquidity risk will make the firm care more about the liquidity constraints. The optimal coupon shows a “U-shaped” function of internal liquidity. The optimal debt pricing depends on either coupon payment or project value, which bases on the internal liquidity. Finally, our model gives an alternative explanation for the long-time unconcluded findings of the relationship between leverage and liquidity in empirical studies.

Suggested Citation

  • Xu, Qing & Yang, Jinqiang, 2017. "Real option with liquidity constraints under secondary debt illiquidity risk market," Finance Research Letters, Elsevier, vol. 21(C), pages 57-65.
    • Handle: RePEc:eee:finlet:v:21:y:2017:i:c:p:57-65
    DOI: 10.1016/j.frl.2017.02.003
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    Cited by:

    1. Ripamonti, Alexandre, 2019. "Capital Structure Adjustments and Asymmetric Information," MPRA Paper 96936, University Library of Munich, Germany.
    2. Luo, Pengfei & Chen, Biao & Liu, Fengjun, 2020. "Growth option, debt maturity and cash reserves with bank-tax-interaction," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).

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    More about this item

    Keywords

    Real option; Liquidity constraints; Optimal capital structure; Illiquidity risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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