Investment and Credit Risk: A Structural Approach

44 Pages Posted: 20 Nov 2006  

Andrea Gamba

University of Warwick - Finance Group

Mamen Aranda

University of Navarra - Business

Daniele Poiega

PricewaterhouseCoopers LLP

Date Written: June 2007

Abstract

The paper investigates the impact on credit risk of capital structure choices driven by firm's investments and financing decisions. We propose a realistic dynamic structural model featuring endogenous investment, capital structure and default. We calibrate the model on accounting and market data. Using simulation, we find that, credit spreads as well as other standard metrics of credit worthiness, like quasi-market leverage, default rate, and the distribution of firms across rating classes, are well fitted by the model. We find that the introduction of investment flexibility has the largest impact on credit risk among the studied features, because of an inherent under-investment agency cost created by debt and because equityholders do not follow a value maximizing capital structure policy.

Keywords: dynamic capital structure, investment, credit risk, underinvestment

JEL Classification: G12, G31, G32, E22

Suggested Citation

Gamba, Andrea and Aranda, Mamen and Poiega, Daniele, Investment and Credit Risk: A Structural Approach (June 2007). Available at SSRN: https://ssrn.com/abstract=945968 or http://dx.doi.org/10.2139/ssrn.945968

Andrea Gamba (Contact Author)

University of Warwick - Finance Group ( email )

Scarman Road
Coventry, CV4 7AL
Great Britain
+44 (0)24 765 24 542 (Phone)
+44 (0)24 765 23 779 (Fax)

Carmen Maria Aranda León

University of Navarra - Business ( email )

Edificio Bibliotecas-Este
Pamplona, 31080
Spain

Daniele Poiega

PricewaterhouseCoopers LLP ( email )

Royal Trust Tower
77 King St. West
Toronto, Ontario M5K 1G8
Canada
(416) 941 8383 ext. 13879 (Phone)

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