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Optimal capital structure and endogenous default

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Author Info
Bianca Hilberink () (Department of Mathematical Sciences, University of Bath, Bath BA2 7AY, UK)
L.C.G. Rogers () (Department of Mathematical Sciences, University of Bath, Bath BA2 7AY, UK)

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Abstract

In a sequence of fascinating papers, Leland and Leland and Toft have investigated various properties of the debt and credit of a firm which keeps a constant profile of debt and chooses its bankruptcy level endogenously, to maximise the value of the equity. One feature of these papers is that the credit spreads tend to zero as the maturity tends to zero, and this is not a feature which is observed in practice. This defect of the modelling is related to the diffusion assumptions made in the papers referred to; in this paper, we take a model for the value of the firm's assets which allows for jumps, and find that the spreads do not go to zero as maturity goes to zero. The modelling is quite delicate, but it just works; analysis takes us a long way, and for the final steps we have to resort to numerical methods.

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Publisher Info
Article provided by Springer in its journal Finance and Stochastics.

Volume (Year): 6 (2002)
Issue (Month): 2 ()
Pages: 237-263
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Handle: RePEc:spr:finsto:v:6:y:2002:i:2:p:237-263

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Related research
Keywords: Credit risk; optimal capital structure; Wiener-Hopf factorisation; corporate debt; default;

Other versions of this item:

Find related papers by JEL classification:
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

Cited by:
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  1. Svetlana Boyarchenko & Sergei Levendorskii, 2005. "American options: the EPV pricing model," Annals of Finance, Springer, vol. 1(3), pages 267-292, 08. [Downloadable!] (restricted)
    Other versions:
  2. Décamps, Jean-Paul & Villeneuve, Stéphane, 2008. "On the Modeling of Debt Maturity and Endogenous Default: A Caveat," IDEI Working Papers 528, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Svetlana Boyarchenko & Sergey Levendorskiy, 2004. "Optimal stopping made easy," Finance 0410016, EconWPA. [Downloadable!]
    Other versions:
  4. Olivier Le Courtois & François Quittard-Pinon, 2008. "The optimal capital structure of the firm with stable Lévy assets returns," Decisions in Economics and Finance, Springer, vol. 31(1), pages 51-72, May. [Downloadable!] (restricted)
  5. Olivier Le Courtois & François Quittard-Pinon, 2006. "Risk-neutral and actual default probabilities with an endogenous bankruptcy jump-diffusion model," Asia-Pacific Financial Markets, Springer, vol. 13(1), pages 11-39, March. [Downloadable!] (restricted)
  6. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Universal bad news principle and pricing of options on dividend-paying assets," Quantitative Finance Papers cond-mat/0404108, arXiv.org. [Downloadable!]
  7. Abel Elizalde, 2006. "Credit Risk Models Ii: Structural Models," Working Papers wp2006_0606, CEMFI. [Downloadable!]
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