Growth Options and Credit Risk

68 Pages Posted: 11 Jul 2016 Last revised: 13 Mar 2018

Andrea Gamba

University of Warwick - Finance Group

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: March 6, 2018

Abstract

We calibrate a dynamic model of credit risk and analyze the relation between growth options and credit spreads. Our model features real and financing frictions, a technology with decreasing returns to scale, and endogenous investment options driven by both systematic and idiosyncratic shocks. We find a negative relation between credit spreads and growth options, after controlling for determinants of credit risk. This negative relation is due to the current decision to invest and the associated change in leverage which, in the presence of external financing needs and financing frictions, increase credit spreads while reducing the value of future investments. We do not find evidence that growth options accrue value in response to systematic risk, thus increasing credit risk premia.

Keywords: growth options, capital structure, credit risk

JEL Classification: G12, G32

Suggested Citation

Gamba, Andrea and Saretto, Alessio, Growth Options and Credit Risk (March 6, 2018). WBS Finance Group Research Paper. Available at SSRN: https://ssrn.com/abstract=2807300 or http://dx.doi.org/10.2139/ssrn.2807300

Andrea Gamba (Contact Author)

University of Warwick - Finance Group ( email )

Scarman Road
Coventry, CV4 7AL
Great Britain
+44 (0)24 765 24 542 (Phone)
+44 (0)24 765 23 779 (Fax)

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)

HOME PAGE: http://www.utdallas.edu/~axs125732

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