Risky Debt Dynamic, Jumps and Optimal Financial Policy

72 Pages Posted: 17 Oct 2006

See all articles by Jean Claude Gabillon

Jean Claude Gabillon

University of Toulouse III

Laurent Germain

Toulouse University, Toulouse Business School

Date Written: October 2006

Abstract

The model developed is a structural valuation model of risky debt which includes a dynamic of debt. The value of the firm follows a jump diffusion process. The default threshold like the recovery rate are endogenous. Consequently, the optimal default threshold changes as the firm's debt level evolves. The spread curves in terms of maturities have levels and forms that are closer to empirical observations. The problem of the dynamic optimal financial structure is reformulated within this framework. Under certain conditions, it is shown that the leverage ratio of the firm follows a double barrier process, one absorbent, the other reflective. But in a perfect financial market (without financial costs) there is no optimal capital structure when the default is predictive. With jumps we can obtain an optimal financial structure as in Modigliani and Miller works.

Keywords: Credit spreads, Optimal capital structure, Jumps, Risky debt, Structural Models

JEL Classification: G12, G13, G32, G33

Suggested Citation

Gabillon, Jean Claude and Germain, Laurent, Risky Debt Dynamic, Jumps and Optimal Financial Policy (October 2006). Available at SSRN: https://ssrn.com/abstract=938148 or http://dx.doi.org/10.2139/ssrn.938148

Jean Claude Gabillon

University of Toulouse III ( email )

118 Route de Narbonne
Toulouse cedex 9, F-31062
France

Laurent Germain (Contact Author)

Toulouse University, Toulouse Business School ( email )

20, bd Lascrosses
Toulouse, 31000
France

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