Real option, debt maturity and equity default swaps under negotiation

Liu Gan, Pengfei Luo and Zhaojun Yang

Finance Research Letters, 2016, vol. 18, issue C, 278-284

Abstract: We consider an investment option, of which the sunk cost is financed by entering into a fee-for-guarantee swap (FGS) or equity-for-guarantee swap (EGS). Debt has a finite maturity and guarantee costs depend on negotiation. We explicitly derive guarantee costs and the pricing and timing of the option. Under negotiation, borrowers get partial option value depending on his bargaining power and insurers gain the remaining value. We discover that EGSs are better than FGSs in borrowers’ view. Guarantee costs generally increase with funding gaps and investment thresholds decrease with debt maturities. The option value decreases first and then increases with debt maturity.

Keywords: Real options; Equity default swaps; Debt maturity; Negotiation (search for similar items in EconPapers)
JEL-codes: G11 G32 (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:18:y:2016:i:c:p:278-284

DOI: 10.1016/j.frl.2016.04.028

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