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Book Values and Market Values of Equity and Debt

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  • Marco Realdon

Abstract

This paper propses a contingent claims model to value a firm's debt and equity as functions of observable book values appearing in published financial statements. Equity fair value critically depends on expected earnings, equity book value and earnings volatility, because of the options to default or to voluntarily liquidate the firms. Debt value increases in earnings volability in the proximity of default. Default is triggered by the erosion of equity due to negative earnings. Debt and equity values are materially affected by the strength of the mean reversion of profitability. Voluntary liquidation before default may be optimal and it entails that a sudden sharp decline in profitability can be less detrimental to creditors than a slower but persistent one.

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File URL: http://www.york.ac.uk/media/economics/documents/discussionpapers/2006/0611.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of York in its series Discussion Papers with number 06/11.

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Date of creation: Jun 2006
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Handle: RePEc:yor:yorken:06/11

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Keywords: Book values; mean reverting return on assets; equity valuation; debt valuation; default option; structural models; voluntary liquidation.;

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