Subordinated Debt and Equity: Complements or Substitutes?

Posted: 24 Feb 2002

Date Written: February 2002

Abstract

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

Nivorozhkin, Eugene, Subordinated Debt and Equity: Complements or Substitutes? (February 2002). EFA 2002 Berlin Meetings Discussion Paper. Available at SSRN: https://ssrn.com/abstract=301033

Eugene Nivorozhkin (Contact Author)

SSEES, University College London ( email )

SSEES, UCL,
Gower Street,
London, WC1E 6BT
United Kingdom
:+44 (0) 2076798811 (Phone)

HOME PAGE: http://www.homepages.ucl.ac.uk/~tjmseni/

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