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A Continuous-Time Analysis of Optimal Defaultable Debt Contracts: Theory and Applications

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  • Hisashi Nakamura

    (Faculty of Economics, University of Tokyo)

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    Abstract

    This paper presents a new approach for modeling continuous-time defaultable debt contracts. It studies an optimal competitive debt contract in continuous time by exploring a dynamic costly monitoring model under asymmetric information in a common-agency setting. It shows that, under an optimal debt contract, a fully informed debtor defaults strategically and recurrently. On the other hand, a less informed creditor expects default to occur stochastically based on an exponential probability distribution under which the arrival rate of default is increasing in monitoring ability. This paper provides a mathematically tractable framework to analyze firms' financial structure and dynamic auditing problems in labor and insurance contracts.

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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-421.

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    Length: 34pages
    Date of creation: May 2006
    Date of revision:
    Handle: RePEc:tky:fseres:2006cf421

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