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 Luetkebohmert

Eva Luetkebohmert

University of Freiburg, Institute for Economic Research; affiliation not provided to SSRN

Daniel Oeltz

RIVACON

Yajun Xiao

Xi'an Jiaotong-Liverpool University (XJTLU)

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

Luetkebohmert, 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 Luetkebohmert (Contact Author)

University of Freiburg, Institute for Economic Research ( email )

Rempartstr. 16
Freiburg, D-79098
Germany

affiliation not provided to SSRN

Daniel Oeltz

RIVACON ( email )

Im Apfelgrund 4
Friedrichsdorf, 61381
Germany

Yajun Xiao

Xi'an Jiaotong-Liverpool University (XJTLU) ( email )

111 Renai Road, SIP
JiangSu province 215123
China

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