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Strategic Default Jump as Impulse Control in Continuous Time

  • Hisashi Nakamura

    (Faculty of Economics, University of Tokyo)

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    This paper presents a new approach for modeling an optimal debt contract in continuous time. It examines a competing contract design in a continuous-time environment with Markov income shocks and costly veri able information. It shows that an optimal contract has the form of a long-term debt contract that permits a debtor's strategic default and debt restructuring. The default is characterized by a recurrent, optimal impulse control beyond default. Numerical examples show that the equilibrium probability of the default is decreasing in the monitoring technology level when the default causes a big wealth loss.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2007/2007cf532.pdf
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    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-532.

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    Length: 28 pages
    Date of creation: Dec 2007
    Date of revision:
    Handle: RePEc:tky:fseres:2007cf532
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    1. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June.
    2. Umut Cetin & Robert Jarrow & Philip Protter & Yildiray Yildirim, 2004. "Modeling Credit Risk with Partial Information," Papers math/0407060, arXiv.org.
    3. Jarrow, Robert A & Turnbull, Stuart M, 1995. " Pricing Derivatives on Financial Securities Subject to Credit Risk," Journal of Finance, American Finance Association, vol. 50(1), pages 53-85, March.
    4. Bruno Biais & Thomas Mariotti & Guillaume Plantin & Jean-Charles Rochet, 2007. "Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 345-390.
    5. 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.
    6. Leo K. Simon and Maxwell B. Stinchcombe., 1987. "Extensive Form Games in Continuous Time: Pure Strategies," Economics Working Papers 8746, University of California at Berkeley.
    7. Duffee, Gregory R, 1999. "Estimating the Price of Default Risk," Review of Financial Studies, Society for Financial Studies, vol. 12(1), pages 197-226.
    8. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous-Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    9. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
    10. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
    11. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics.
    12. Michael Peters, 1999. "Common Agency and the Revelation Principle," Working Papers peters-99-01, University of Toronto, Department of Economics.
    13. Hisashi Nakamura, 2006. "A Dynamic Theory of Debt Restructuring," CARF F-Series CARF-F-072, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    14. Hisashi Nakamura, 2006. "A Dynamic Theory of Debt Restructuring," CIRJE F-Series CIRJE-F-433, CIRJE, Faculty of Economics, University of Tokyo.
    15. Black, Fischer & Cox, John C, 1976. "Valuing Corporate Securities: Some Effects of Bond Indenture Provisions," Journal of Finance, American Finance Association, vol. 31(2), pages 351-67, May.
    16. Epstein, Larry G. & Peters, Michael, 1999. "A Revelation Principle for Competing Mechanisms," Journal of Economic Theory, Elsevier, vol. 88(1), pages 119-160, September.
    17. Darrell Duffie & Lasse Heje Pedersen & Kenneth J. Singleton, 2003. "Modeling Sovereign Yield Spreads: A Case Study of Russian Debt," Journal of Finance, American Finance Association, vol. 58(1), pages 119-159, 02.
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