The Valuation of Corporate Debt With Default Risk

Abstract:     
This article develops a continuous time asset pricing model of debt restructuring and values equity and debt by taking into account the fact that in practice the default point differs from the liquidation point. This separation allows us to delegate the liquidation decision to the creditors whilst default is triggered by the managers. The study identifies an agency cost of debt whereby the creditors liquidate the firm prematurely relative to the first best threshold.

Keywords: Debt pricing, default risk, premature liquidation

JEL Classifications: G12, G33

Working Paper Series