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The Mills Ratio and the behavior of redeemable bond prices in the Gaussian structural model of corporate default

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  • Spencer, Peter

Abstract

This paper shows that forward default intensities in the Black and Cox (1976) model of corporate default can be expressed in terms of the Mills Ratio (Mills, 1926). The behaviour of the forward default intensity and hence the survivorship functions then follows from inequalities that are satisfied by this ratio. This allows me to analyze the effect of the firm’s distance to default, growth rate and volatility upon the value of its debt. These results can be used to analyze the comparative static properties of other models of corporate default and perhaps other first passage time models.

Suggested Citation

  • Spencer, Peter, 2014. "The Mills Ratio and the behavior of redeemable bond prices in the Gaussian structural model of corporate default," Finance Research Letters, Elsevier, vol. 11(1), pages 8-15.
    • Handle: RePEc:eee:finlet:v:11:y:2014:i:1:p:8-15
    DOI: 10.1016/j.frl.2013.05.006
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    References listed on IDEAS

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    1. Hackbarth, Dirk & Miao, Jianjun & Morellec, Erwan, 2006. "Capital structure, credit risk, and macroeconomic conditions," Journal of Financial Economics, Elsevier, vol. 82(3), pages 519-550, December.
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    5. Leland, Hayne E & Toft, Klaus Bjerre, 1996. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
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    Cited by:

    1. Peter Spencer, 2013. "Modeling US bank CDS spreads during the Global Financial Crisis with a deferred filtration pricing model," Discussion Papers 13/18, Department of Economics, University of York.
    2. Spencer, Peter, 2016. "US bank credit spreads during the financial crisis," Journal of Banking & Finance, Elsevier, vol. 71(C), pages 168-182.
    3. Peter Spencer, 2013. "The behavior of the hazard rate in the Gaussian structural default model under asymmetric information," Discussion Papers 13/23, Department of Economics, University of York.

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    More about this item

    Keywords

    Bankruptcy; Corporate bond pricing; First passage time; Mills Ratio inequalities; Comparative statics;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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