Subordinated Debt and Equity: Complements or Substitutes?
Posted: 24 Feb 2002
Date Written: February 2002
The paper extends the contingent valuation framework of Black and Cox (1976) to value subordinated debt by explicitly incorporating bankruptcy costs in the model. I show that subordinated debt prices have 'value added' relative to equity. In fact, the joint use of equity and subordinated debt prices can provide information on magnitude of expected bankruptcy costs. Knowing the magnitude of expected bankruptcy costs is necessary for calculating variables underlying policy objectives. In particular, it is illustrated that the value of expected liability of a deposit insurer would be underestimated if the bankruptcy costs were not taken into account.
Keywords: bank, subordinated debt, equity, bankruptcy costs, deposit insurance
JEL Classification: G12, G13, G21, G28, G33
Suggested Citation: Suggested Citation