Strategic Default Jump as Impulse Control in Continuous Time ( Revised in February 2008 )

Hisashi Nakamura
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Hisashi Nakamura: Faculty of Economics, University of Tokyo

No CARF-F-115, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This paper presents a new approach for modeling an optimal debt contract in continuous time. It examines a competing contract design in a continuous-time environment with Markov income shocks and costly verifiable information. It shows that an optimal contract has the form of a debt contract that permits a debtor's strategic default and reorganization. The default is formulated as an optimal impulse control. This paper provides a useful framework to investigate the debtor's default incentives in relationships to a monitoring technology. Numerical examples show that the equilibrium probability of the default is decreasing in a level of the monitoring technology.

Pages: 28 pages
Date: 2007-12
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Persistent link: https://EconPapers.repec.org/RePEc:cfi:fseres:cf115

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