Reference

Jean-Paul Décamps, and Stéphane Villeneuve, “Rethinking Dynamic Capital Structure Models with Roll-Over Debt”, Mathematical Finance, vol. 24, n. 1, January 2014, pp. 66–96.

Abstract

Dynamic capital structure models with roll-over debt rely on widely accepted arguments that have never been formalized. This paper clarifies the literature and provides a rigorous formulation of the equity holders' decision problem within a game theory framework. We spell out the linkage between default policies in a rational expectations equilibrium and optimal stopping theory. We prove that there exists a unique equilibrium in constant barrier strategies, which coincides with that derived in the literature. Furthermore, that equilibrium is the unique equilibrium when the firm loses all its value at default time. Whether the result holds when there is a recovery at default remains a conjecture.

Keywords

strategic default; payoff dominant equilibrium; constrained optimal stopping time;

JEL codes

  • C61: Optimization Techniques • Programming Models • Dynamic Analysis
  • G33: Bankruptcy • Liquidation

Research partnerships

Methodology of Credit Risk Models
Regulation, Liquidity and Solvency Risks

Replaces

Jean-Paul Décamps, and Stéphane Villeneuve, “Rethinking Dynamic Capital Structure Models with Roll-Over Debt”, IDEI Working Paper, n. 528, November 2009, revised November 2011.