Market Imperfections, Investment Optionality and Default Spreads

50 Pages Posted: 4 Dec 2001

See all articles by Stathis Tompaidis

Stathis Tompaidis

University of Texas at Austin - McCombs School of Business

Sergey Tsyplakov

University of South Carolina - Darla Moore School of Business

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: November 28, 2001

Abstract

This paper develops a structural model that determines default spreads on risky debt. In contrast to previous research, the value of the debt's collateral is endogenously determined by the borrower's investment choice, as well as by a market demand variable that has permanent as well as temporary components. The model also considers market imperfections that limit the borrower's ability to contract to undertake the value-maximizing investment choice, and which may in addition limit the borrower's ability to raise external capital. The model is calibrated with data on commercial mortgages, and based on our calibration, we present numerical simulations that quantify the extent to which investment flexibility, incentive problems and credit constraints affect default spreads.

Keywords: debt pricing, default spreads, agency cost, market imperfections, contracting environment

JEL Classification: G12,G13,G21,G31,G32,G35

Suggested Citation

Tompaidis, Stathis and Tsyplakov, Sergey and Titman, Sheridan, Market Imperfections, Investment Optionality and Default Spreads (November 28, 2001). Available at SSRN: https://ssrn.com/abstract=292731 or http://dx.doi.org/10.2139/ssrn.292731

Stathis Tompaidis

University of Texas at Austin - McCombs School of Business ( email )

Austin, TX 78712
United States

Sergey Tsyplakov

University of South Carolina - Darla Moore School of Business ( email )

Francis M. Hipp Building
Finance Department
Columbia, SC 29208
United States
803-777-4669 (Phone)
803-777-6876 (Fax)

HOME PAGE: http://dmsweb.moore.sc.edu/tsyplakov/

Sheridan Titman (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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