Credit risk and asymmetric information: A simplified approach

Snorre Lindset, Arne-Christian Lund and Svein-Arne Persson

Journal of Economic Dynamics and Control, 2014, vol. 39, issue C, 98-112

Abstract: We present a simple model for risky, corporate debt. Debtholders and equityholders have incomplete information about the financial state of the debt issuing company. Information is incomplete because it is delayed for all agents, and it is asymmetrically distributed between debtholders and equityholders. We solve for the equityholders' optimal default policy and for the credit spreads required by debtholders. Delayed information accelerates the equityholders' optimal decision to default. Interestingly, this effect is small, implying only a small impact on credit spreads. Asymmetric information, however, has a major impact on credit spreads. Our model predicts high credit spreads for short-term debt, as observed empirically in credit markets.

Keywords: Default policy; Credit spreads; Incomplete information (search for similar items in EconPapers)
JEL-codes: G12 G33 (search for similar items in EconPapers)
Date: 2014
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:39:y:2014:i:c:p:98-112

DOI: 10.1016/j.jedc.2013.11.006

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