The investment policy and the pricing of equity in a levered firm: a re-examination of the 'contingent claims' valuation approach

M. Chesney and R. Gibson-Asner

The European Journal of Finance, 1999, vol. 5, issue 2, 95-107

Abstract: In this study we re-examine the pricing of equity and the risk incentives of shareholders in levered firms. We derive a down-and-out call equity valuation model which rests on the assumption that shareholders choose the optimal investment and asset returns' volatility as a function of current leverage. Contrarily to the Black and Scholes framework where, irrespective of the firm's leverage, they would always select infinite volatility projects, here the more deep out-of-the-money the shareholders' claim, the greater their incentives to select riskier investment projects. The model is thus consistent with and quantifies the asset substitution problem previously acknowledged by the agency literature.

Keywords: Agency Problems; Asset Substitution; Contingent Claim; Down-and-out Call Option; Capital Structure; Leverage; Risk Incentives (search for similar items in EconPapers)
Date: 1999
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/135184799337118 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:eurjfi:v:5:y:1999:i:2:p:95-107

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/REJF20

DOI: 10.1080/135184799337118

Access Statistics for this article

The European Journal of Finance is currently edited by Chris Adcock

More articles in The European Journal of Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().