Optimal Capital Structure with Endogenous Default and Volatility Risk
This paper analyzes the capital structure of a firm in an infinite time horizon following Leland (1994) under the more general hypothesis that the firm’s assets value process belongs to a fairly large class of stochastic volatility models. By applying singular perturbation theory, we fully describe the (approximate) capital structure of the firm in closed form as a corrected version of Leland (1994) and analyze the stochastic volatility effect on all financial variables. We propose a corrected version of the smooth-fit principle under volatility risk useful to determine the optimal stopping problem solution (i.e. endogenous failure level) and a corrected version for the Laplace transform of the stopping failure time. The numerical analysis obtained from exploiting optimal capital structure shows enhanced spreads and lower leverage ratios w.r.t. Leland (1994), improving results in a robust model-independent way.
|Date of creation:||Jan 2012|
|Contact details of provider:|| Postal: Via delle Pandette 9 50127 - Firenze - Italy|
Phone: +39 055 2759707
Fax: +39 055 2759913
Web page: http://www.disei.unifi.it/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Svetlana Boyarchenko & Sergei Levendorskii, 2004.
"Real options and the universal bad news principle,"
- Nan Chen & S. G. Kou, 2009. "Credit Spreads, Optimal Capital Structure, And Implied Volatility With Endogenous Default And Jump Risk," Mathematical Finance, Wiley Blackwell, vol. 19(3), pages 343-378.
- Jukka Lempa, 2008.
"On infinite horizon optimal stopping of general random walk,"
Mathematical Methods of Operations Research,
Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 67(2), pages 257-268, April.
- Jukka Lempa, 2006. "On Infinite Horizon Optimal Stopping of General Random Walk," Discussion Papers 3, Aboa Centre for Economics.
- Décamps, Jean-Paul & Mariotti, Thomas & Rochet, Jean-Charles & Villeneuve, Stéphane, 2008. "Free Cash-Flow, Issuance Costs and Stock Price Volatility," IDEI Working Papers 518, Institut d'Économie Industrielle (IDEI), Toulouse.
- : David Kelsey & Roman Kozhan & Wei Pang, 2010.
"Asymmetric Momentum Effects Under Uncertainty,"
wpn10-04, Warwick Business School, Finance Group.
- 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.
- Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
- Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Universal bad news principle and pricing of options on dividend-paying assets," Papers cond-mat/0404108, arXiv.org.
- Bianca Hilberink & L.C.G. Rogers, 2002. "Optimal capital structure and endogenous default," Finance and Stochastics, Springer, vol. 6(2), pages 237-263.
- T. R. Hurd, 2009. "Credit Risk Modeling Using Time-Changed Brownian Motion," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 12(08), pages 1213-1230.
- Tim Bollerslev & Natalia Sizova & George Tauchen, 2009.
"Volatility in Equilibrium: Asymmetries and Dynamic Dependencies,"
CREATES Research Papers
2009-05, Department of Economics and Business Economics, Aarhus University.
- Tim Bollerslev & Natalia Sizova & George Tauchen, 2011. "Volatility in Equilibrium: Asymmetries and Dynamic Dependencies," Review of Finance, European Finance Association, vol. 16(1), pages 31-80.
- Tim Bollerslev & Natalia Sizova & George Tauchen, 2009. "Volatility in Equilibrium: Asymmetries and Dynamic Dependencies," Working Papers 10-73, Duke University, Department of Economics.
- Tim Bollerslev & Natalia Sizova & George Tauchen, 2010. "Volatility in Equilibrium: Asymmetries and Dynamic Dependencies," Working Papers 10-34, Duke University, Department of Economics.
- Medvedev, Alexey & Scaillet, Olivier, 2010. "Pricing American options under stochastic volatility and stochastic interest rates," Journal of Financial Economics, Elsevier, vol. 98(1), pages 145-159, October.
- Filippo Fiorani & Elisa Luciano & Patrizia Semeraro, 2007. "Single and joint default in a structural model with purely discontinuous assets," Carlo Alberto Notebooks 41, Collegio Carlo Alberto.
- Zhou, Chunsheng, 2001. "The term structure of credit spreads with jump risk," Journal of Banking & Finance, Elsevier, vol. 25(11), pages 2015-2040, November.
- Kyo Yamamoto & Akihiko Takahashi, 2009. "A Remark on a Singular Perturbation Method for Option Pricing Under a Stochastic Volatility Model," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 16(4), pages 333-345, December.
- Merton, Robert C, 1974.
"On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,"
Journal of Finance,
American Finance Association, vol. 29(2), pages 449-470, May.
- Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- T. R. Hurd, 2009. "Credit risk modeling using time-changed Brownian motion," Papers 0904.2376, arXiv.org.
- Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
- Leland, Hayne E, 1994.
" Corporate Debt Value, Bond Covenants, and Optimal Capital Structure,"
Journal of Finance,
American Finance Association, vol. 49(4), pages 1213-1252, September.
- Hayne E. Leland., 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Research Program in Finance Working Papers RPF-233, University of California at Berkeley.
- Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
- Hans Gersbach & Nicolae Surulescu, 2010. "Default Risk in Stochastic Volatility Models," CER-ETH Economics working paper series 10/131, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
- Giesecke, Kay, 2004. "Correlated default with incomplete information," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1521-1545, July.
When requesting a correction, please mention this item's handle: RePEc:flo:wpaper:2012-02. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Michele Gori)
If references are entirely missing, you can add them using this form.