A Model of Credit Risk, Optimal Policies and Asset Prices
AbstractThis Paper studies the optimal policies of borrowers (firms or individuals) who may default subject to default costs, and analyses the asset pricing implications. Borrowers defaulting under adverse economic conditions may, despite incurring default costs, emerge as wealthier than non-borrowers or those who can default costlessly. Under many economic scenarios, borrowers take on less risk exposure than non-borrowers. A larger risk exposure by borrowers may occur as well, however, depending on the structure of default costs and on how debt maturity relates to the planning horizon. In the latter case, borrowers' default policies render binary options useful instruments for lenders in hedging the credit-risk component of their assets. In our model, the asset-value dynamics are endogenously determined, and are shown to exhibit stochastic mean return and volatility in contrast to the exogenously assumed constant mean and volatility in many credit risk models. We consider a variety of extensions, including equilibrium, where a lower (higher) risk exposure by borrowers manifests itself in an attenuated (amplified) market volatility and risk premium, but the market value is always higher in economic downturns, and lower in upturns, compared to an economy without the presence of credit risk.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3413.
Date of creation: Jun 2002
Date of revision:
Contact details of provider:
Postal: Centre for Economic Policy Research, 77 Bastwick Street, London EC1V 3PZ
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820
Other versions of this item:
- Suleyman Basak & Alexander Shapiro, 2005. "A Model of Credit Risk, Optimal Policies, and Asset Prices," The Journal of Business, University of Chicago Press, vol. 78(4), pages 1215-1266, July.
- C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
- D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2003-02-18 (All new papers)
- NEP-CFN-2003-02-18 (Corporate Finance)
- NEP-FIN-2003-02-18 (Finance)
- NEP-RMG-2003-02-18 (Risk Management)
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- Li Chen & H. Vincent Poor, 2003. "Information Asymmetry, Corporate Debt Financing and Optimal Investment Decisions: A Reduced Form Approach," Finance 0312008, EconWPA.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.