Real option with liquidity constraints under secondary debt illiquidity risk market

Qing Xu and Jinqiang Yang

Finance Research Letters, 2017, vol. 21, issue C, 57-65

Abstract: We incorporate the illiquidity risk subjects to the secondary debt markets into the real option framework with liquidity financing constraints. Our model shows that the investment threshold and optimal leverage no longer monotonically increase in project risk but are up to internal liquidity, and illiquidity risk will make the firm care more about the liquidity constraints. The optimal coupon shows a “U-shaped” function of internal liquidity. The optimal debt pricing depends on either coupon payment or project value, which bases on the internal liquidity. Finally, our model gives an alternative explanation for the long-time unconcluded findings of the relationship between leverage and liquidity in empirical studies.

Keywords: Real option; Liquidity constraints; Optimal capital structure; Illiquidity risk (search for similar items in EconPapers)
JEL-codes: C61 G11 G23 G31 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:21:y:2017:i:c:p:57-65

DOI: 10.1016/j.frl.2017.02.003

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