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Valuation of Defaultable Bonds and Debt Restructuring

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Abstract

In this paper we develop a contingent valuation model for zero-coupon bonds with default. In order to emphasize the role of maturity time and place of the lender’s claim in the hierarchy of debt of a firm, we consider a firm that issues two bonds with different maturities and different seniorage. The model allows us to analyze the implications of both debt renegotiation and capital structure of a firm on the prices of bonds. We obtain that renegotiation brings about a significant change in the bond prices and that the effect is dispersed through different channels: increasing the value of the firm, reallocating payments, and avoiding costly liquidation. Moreover, the presence of two creditors leads to qualitatively different implications for pricing, while emphasizing the importance of bond covenants and renegotiation of the entire debt.

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Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 590.03.

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Length: 23
Date of creation: 08 Oct 2003
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Handle: RePEc:aub:autbar:590.03

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Keywords: Debt valuation; Defaultable bonds; Strategic contingent claim analysis; Modigliani-Miller theorem;

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  1. Gregor Andrade & Steven N. Kaplan, 1998. "How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," Journal of Finance, American Finance Association, vol. 53(5), pages 1443-1493, October.
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  7. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
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  13. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
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  15. Fries, Steven & Miller, Marcus & Perraudin, William, 1997. "Debt in Industry Equilibrium," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 39-67.
  16. Anderson, Ronald W. & Sundaresan, Suresh & Tychon, Pierre, 1996. "Strategic analysis of contingent claims," European Economic Review, Elsevier, vol. 40(3-5), pages 871-881, April.
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Cited by:
  1. Abínzano, Isabel & Seco, Luis & Escobar, Marcos & Olivares, Pablo, 2009. "Single and Double Black-Cox: Two approaches for modelling debt restructuring," Economic Modelling, Elsevier, vol. 26(5), pages 910-917, September.
  2. Bruche, Max & Naqvi, Hassan, 2010. "A structural model of debt pricing with creditor-determined liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 34(5), pages 951-967, May.

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