A Continuous-Time Analysis of Optimal Defaultable Debt Contracts: Theory and Applications

Hisashi Nakamura
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Hisashi Nakamura: Faculty of Economics, University of Tokyo

No CIRJE-F-421, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: This paper presents a new approach for modeling continuous-time defaultable debt contracts. It studies an optimal competitive debt contract in continuous time by exploring a dynamic costly monitoring model under asymmetric information in a common-agency setting. It shows that, under an optimal debt contract, a fully informed debtor defaults strategically and recurrently. On the other hand, a less informed creditor expects default to occur stochastically based on an exponential probability distribution under which the arrival rate of default is increasing in monitoring ability. This paper provides a mathematically tractable framework to analyze firms' financial structure and dynamic auditing problems in labor and insurance contracts.

Pages: 34pages
Date: 2006-05
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Persistent link: https://EconPapers.repec.org/RePEc:tky:fseres:2006cf421

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