Risk and the Optimal Debt Level

Jeffrey Jaffe and Randolph Westerfield

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: Financial economists have generally asserted that, in a world of corporate taxes and bankruptcy costs, the debt level of a firm is negatively related to its risk. Surprisingly, our paper shows that neither the face value of debt, the market value of debt, nor the ratio of market value of debt to market value of equity need be a negative function of a firm's variability.

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