Skip to main content

Please enter a keyword and click the arrow to search the site

When does strategic debt service matter?

Subject

Finance

Publishing details

Authors / Editors

Acharya V et al

Publication Year

2002

Abstract

Recent work has suggested that strategic underperformance of debt-service obligations by equity holders can resolve the gap between observed yield spreads and those generated by Merton (41)-style models. We shos that this is not quite correct. The value of the option to underperform on debt-service obligations depends on two other optionalities available to equity holders, namely, the option to carry reserves within the firm and the option to raise new external funding. We disentangle the effects of the three factors, and characterize the impact of each in isolation as well as their interaction. We find, among other things, that while strategic behavior can increase spreads significantly under some conditions, its impact is negligible in others, and in some cases it even leads to a decline in equilibrium spreads. We show that this last apparently paradoxical result is a consequence of an interaction of optionalities that results in a trade-off between strategic and liquidity-driven defaults.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 362

Series

IFA Working Paper

Available on ECCH

No


Select up to 4 programmes to compare

Select one more to compare
×
subscribe_image_desktop 5949B9BFE33243D782D1C7A17E3345D0

Sign up to receive our latest news and business thinking direct to your inbox

×

Sign up to receive our latest course information and business thinking

Leave your details above if you would like to receive emails containing the latest thought leadership, invitations to events and news about courses that could enhance your career. If you would prefer not to receive our emails, you can still access the case study by clicking the button below. You can opt-out of receiving our emails at any time by visiting: https://london.edu/my-profile-preferences or by unsubscribing through the link provided in our emails. View our Privacy Policy for more information on your rights.