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Optimal capital structure and endogenous default

Bianca Hilberink () and L.C.G. Rogers ()
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Bianca Hilberink: Department of Mathematical Sciences, University of Bath, Bath BA2 7AY, UK
L.C.G. Rogers: Department of Mathematical Sciences, University of Bath, Bath BA2 7AY, UK

Finance and Stochastics, 2002, vol. 6, issue 2, 237-263

Abstract: In a sequence of fascinating papers, Leland and Leland and Toft have investigated various properties of the debt and credit of a firm which keeps a constant profile of debt and chooses its bankruptcy level endogenously, to maximise the value of the equity. One feature of these papers is that the credit spreads tend to zero as the maturity tends to zero, and this is not a feature which is observed in practice. This defect of the modelling is related to the diffusion assumptions made in the papers referred to; in this paper, we take a model for the value of the firm's assets which allows for jumps, and find that the spreads do not go to zero as maturity goes to zero. The modelling is quite delicate, but it just works; analysis takes us a long way, and for the final steps we have to resort to numerical methods.

Keywords: Credit risk; optimal capital structure; Wiener-Hopf factorisation; corporate debt; default (search for similar items in EconPapers)
JEL-codes: D92 G32 G33 (search for similar items in EconPapers)
Date: 2002-03-12
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