Debt Contracts and Stochastic Default Barrier

Martin Dózsa (martin@dozsa.cz) and Jakub Seidler
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Martin Dózsa: Institute of Economic Studies, Faculty of Social Sciences, Charles University, Prague, Czech Republic, http://ies.fsv.cuni.cz/

No 2012/17, Working Papers IES from Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies

Abstract: This article presents structural asset pricing model with stochastic interest rate and default barrier based on the evolution of the firm' Earning Before Interest and Taxes (EBIT). This framework is further enhanced by the game theory analysis which examines the negotiation between shareholders and creditors with respect to the debt of the company and its safety covenants serving as the default trigger. As a result, this complex framework allows toanalyse different optimal capital structures of the company and its default probability dependent on the changes in the risk-free interest rate, which may also represent the current state of the economy. As the numerical computations show this approach is more convenient than the constant default barrier framework used in the currently available literature.

Keywords: credit contracts; stochastic default barrier; asset pricing; EBIT-based models; structural models (search for similar items in EconPapers)
JEL-codes: C73 G12 G32 G33 (search for similar items in EconPapers)
Pages: 29pages
Date: 2012-06, Revised 2012-06
New Economics Papers: this item is included in nep-cmp and nep-gth
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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