Credit risk and contagion: Continuous-time optimal contract approach

点击翻译按钮获取中文摘要

This research project studies the role of restructuring in valuing optimally designed long-term securities in a continuous-time model with costly corporate information disclosure. In practice, Merton (1974)'s contingent-claim models have been long used for valuing corporate securities, based mostly on the assumption of some sufficiently complete security structure in markets. On the other hand, in the literature on corporate finance, it has been well known theoretically and empirically that the agency problem (i.e., conflicts of interest among agents) caused by informational asymmetry distorts corporate capital structure. However, the effect of the distortion on security valuation has not been well studied either in theory or in practice. This paper bridges such a gap between the security-valuation literature and the corporate-finance literature. Specifically, first, it shows that, in the agency problem, corporate leverage ratios are higher when restructuring is expected to be accepted in default than otherwise. Also, they can correlate with equity values negatively inter-temporarily. The risk of a jump to liquidation increases the default probability in short term, and decreases the probability of restructuring over time. As a result, this model can resolve the underestimation problem of short-term credit spreads.