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Extension of the Model to Uncertainty

In: Economic Foundations for Finance

Author

Listed:
  • Thorsten Hens

    (University of Zurich)

  • Sabine Elmiger

    (University of Zurich)

Abstract

This chapter extends the model to uncertainty in order to explain the crucial difference between equity and debt. When households hold equity, they face future returns that tend to be high in good times and low in bad times. Thus, they demand a return on equity that is higher than the return on debt as a compensation for the pro-cyclical returns. When firms are maximizing their profits, they will use debt only if the future profits by the use of debt are larger than the costs in terms of interest payments on debt on average.

Suggested Citation

  • Thorsten Hens & Sabine Elmiger, 2019. "Extension of the Model to Uncertainty," Springer Texts in Business and Economics, in: Economic Foundations for Finance, chapter 6, pages 79-109, Springer.
    • Handle: RePEc:spr:sptchp:978-3-030-05427-4_6
    DOI: 10.1007/978-3-030-05427-4_6
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