Endogenous Credit Spreads and Optimal Debt Financing Structure in the Presence of Liquidity Risk

32 Pages Posted: 10 Jan 2017

See all articles by Eva Lütkebohmert

Eva Lütkebohmert

University of Freiburg, Institute for Economic Research

Daniel Oeltz

RIVACON

Yajun Xiao

University College Dublin (UCD)

Date Written: January 2017

Abstract

We present a structural model that allows a firm to effectively manage its exposure to both insolvency and illiquidity risk inherent in its financing structure. Besides insolvency risk, the firm is exposed to rollover risk through possible runs by short‐term creditors. Moreover, asset price volatilities are subject to macroeconomic shocks and influence creditors' risk attitudes and margin requirements. Credit spreads are derived endogenously depending on the firm's total default risk. Equity holders have to bear the rollover losses. An optimal debt structure that maximises the firm's equity value is determined by trading off lower financing costs and higher rollover risk.

Keywords: funding liquidity, optimal capital structure, rollover risk, structural credit risk models

Suggested Citation

Lütkebohmert, Eva and Oeltz, Daniel and Xiao, Yajun, Endogenous Credit Spreads and Optimal Debt Financing Structure in the Presence of Liquidity Risk (January 2017). European Financial Management, Vol. 23, Issue 1, pp. 55-86, 2017, Available at SSRN: https://ssrn.com/abstract=2896444 or http://dx.doi.org/10.1111/eufm.12089

Eva Lütkebohmert (Contact Author)

University of Freiburg, Institute for Economic Research ( email )

Platz der Alten Synagoge 1
Freiburg, D-79098
Germany

Daniel Oeltz

RIVACON ( email )

Im Apfelgrund 4
Friedrichsdorf, 61381
Germany

Yajun Xiao

University College Dublin (UCD) ( email )

Belfield, Dublin 4 4
Ireland

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