Pricing Under Endogenous Capital Structure Changes and Discontinuous Trading

50 Pages Posted: 31 May 2018 Last revised: 11 Sep 2018

See all articles by Diego Ronchetti

Diego Ronchetti

University of Groningen - SOM Research School

Daniël Vullings

Rijksuniversiteit Groningen

Multiple version iconThere are 2 versions of this paper

Date Written: May 30, 2018

Abstract

The knowledge of the type of cash-flows offered by an asset, such as either equity-like or debt-like, is necessary for its net present valuation. Recently, the consequences of trades of assets with ambiguous cash-flows on financial systems have been discussed. Several forms of contingent capital proposed as automatic recapitalization tools for large banks are assets of this type, since the type of cash-flows they provide are not in a unidirectional causal relationship with the capital structure of their issuer. We study the net present valuation of assets of this kind that accounts for the investors' wealth factors, and give sufficient and necessary conditions under discontinuous trading for its existence and uniqueness. We illustrate the pricing method for a firm's debt that is automatically modified when the firm's equity trading price declines to a predetermined level. Depending on its contract characteristics, this debt is either converted into new equity, written-down or written-off. We consider distinct cases with capital structure change favoring either equity or debt holders.

Keywords: endogenous demand, discontinuous trading, capital structure, contingent convertible debt, financial stability

JEL Classification: G12, G13

Suggested Citation

Ronchetti, Diego and Vullings, Daniël, Pricing Under Endogenous Capital Structure Changes and Discontinuous Trading (May 30, 2018). Available at SSRN: https://ssrn.com/abstract=3187757 or http://dx.doi.org/10.2139/ssrn.3187757

Diego Ronchetti (Contact Author)

University of Groningen - SOM Research School ( email )

P.O. Box 800
9700 AV Groningen
Netherlands
+31 50 363 3460 (Phone)
+31 50 363 7337 (Fax)

HOME PAGE: http://www.rug.nl/staff/d.ronchetti/

Daniël Vullings

Rijksuniversiteit Groningen ( email )

0658978557 (Phone)

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