Results 1  10
of
34
Rollover risk and credit risk
 Journal of Finance
, 2012
"... Our model shows that deterioration in debt market liquidity leads to an increase in not only the liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms ’ debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturin ..."
Abstract

Cited by 36 (7 self)
 Add to MetaCart
Our model shows that deterioration in debt market liquidity leads to an increase in not only the liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms ’ debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturing debt, equity holders bear the losses while maturing debt holders are paid in full. This conflict leads the firm to default at a higher fundamental threshold. Our model demonstrates an intricate interaction between the liquidity premium and default premium and highlights the role of shortterm debt in exacerbating rollover risk. THE YIELD SPREAD OF a firm’s bond relative to the riskfree interest rate directly determines the firm’s debt financing cost, and is often referred to as its credit spread. It is widely recognized that the credit spread reflects not only a default premium determined by the firm’s credit risk but also a liquidity premium due to illiquidity of the secondary debt market (e.g., Longstaff, Mithal, and Neis (2005) and Chen, Lesmond, and Wei (2007)). However, academics and policy makers tend to treat both the default premium and the liquidity premium as independent, and thus ignore interactions between them. The financial crisis of 2007 to 2008 demonstrates the importance of such an interaction— deterioration in debt market liquidity caused severe financing difficulties for many financial firms, which in turn exacerbated their credit risk. In this paper, we develop a theoretical model to analyze the interaction between debt market liquidity and credit risk through socalled rollover risk: when debt market liquidity deteriorates, firms face rollover losses from issuing new bonds to replace maturing bonds. To avoid default, equity holders need to bear the rollover losses, while maturing debt holders are paid in full. This
Principles of smooth and continuous fit in the determination of endogenous bankruptcy levels, Finance and Stochastics
"... endogenous bankruptcy levels ..."
(Show Context)
Credit Risk Models with Incomplete Information
, 2007
"... Incomplete information is at the heart of informationbased credit risk models. In this paper, we rigorously define incomplete information with the notion of “delayed filtrations”. We characterize two distinct types of delayed information, continuous and discrete: the first generated by a time chang ..."
Abstract

Cited by 15 (0 self)
 Add to MetaCart
Incomplete information is at the heart of informationbased credit risk models. In this paper, we rigorously define incomplete information with the notion of “delayed filtrations”. We characterize two distinct types of delayed information, continuous and discrete: the first generated by a time change of filtrations and the second by finitely many marked point processes. This notion unifies the noisy information in Duffie and Lando (2001) and the partial information in CollinDufresne et al. (2004), under which structural models are translated into reducedform intensitybased models. We illustrate through a simple example the importance of this notion of delayed information, as well as the potential pitfall for abusing the Laplacian approximation techniques for calculating the intensity process in an informationbased model. The authors are grateful to the Associate Editor and the two anonymous referees for their constructive suggestions and enlightening remarks.
Credit risk modelling using timechanged Brownian motion
, 2007
"... Motivated by the interplay between structural and reduced form credit models, and in particular the rating class model of Jarrow, Lando and Turnbull, we propose to model the firm value process as a timechanged Brownian motion. We are lead to consider modifying the classic first passage problem for ..."
Abstract

Cited by 10 (5 self)
 Add to MetaCart
Motivated by the interplay between structural and reduced form credit models, and in particular the rating class model of Jarrow, Lando and Turnbull, we propose to model the firm value process as a timechanged Brownian motion. We are lead to consider modifying the classic first passage problem for stochastic processes to capitalize on this time change structure. We demonstrate that the distribution functions of such “first passage times of the second kind ” are efficiently computable in a wide range of useful examples, and thus this notion of first passage can be used to define the time of default in generalized structural credit models. General formulas for credit derivatives are then proven, and shown to be easily computable. Finally, we show that by treating many firm value processes as dependent time changes of independent Brownian motions, one can obtain multifirm credit models with rich and plausible dynamics and enjoying the possibility of efficient valuation of portfolio credit derivatives.
Stochastic Volatility and Asset Pricing Puzzles
, 2013
"... This paper builds a realoptions, term structure model of the firm to shed new light on the value premium, financial distress, momentum, and credit spread puzzles. The model incorporates stochastic volatility in the firm productivity process and a negative market price of volatility risk. Since the ..."
Abstract

Cited by 9 (0 self)
 Add to MetaCart
This paper builds a realoptions, term structure model of the firm to shed new light on the value premium, financial distress, momentum, and credit spread puzzles. The model incorporates stochastic volatility in the firm productivity process and a negative market price of volatility risk. Since the equity of growth firms and financially distressed firms have embedded options, such securities hedge against volatility risk in the market and thus command lower volatility risk premia than the equities of value or financially healthy firms. Abnormal riskadjusted momentum profits are concentrated among low creditrating firms for similar reasons. Conversely, since increases in volatility generally reduce the value of debt, corporate debt will tend to command large volatility risk premia, allowing the model to generate higher credit spreads than existing structural models. The paper illustrates that allowing for endogenous default by equityholders is necessary for the model to account for the credit spreads of both investment grade and junk debt. The model is extended to include rare disasters and multiple time scales in volatility dynamics to better account for the expected default frequencies and credit spreads of short maturity debt. Finally, the paper uses a methodology based on asymptotic expansions to solve the model.
ON THE CONTINUOUS AND SMOOTH FIT PRINCIPLE FOR OPTIMAL STOPPING PROBLEMS IN SPECTRALLY NEGATIVE LÉVY MODELS
"... ABSTRACT. We consider a class of infinitetime horizon optimal stopping problems for spectrally negative Lévy processes. Focusing on strategies of threshold type, we write explicit expressions for the corresponding expected payoff via the scale function, and further pursue optimal candidate threshol ..."
Abstract

Cited by 8 (7 self)
 Add to MetaCart
(Show Context)
ABSTRACT. We consider a class of infinitetime horizon optimal stopping problems for spectrally negative Lévy processes. Focusing on strategies of threshold type, we write explicit expressions for the corresponding expected payoff via the scale function, and further pursue optimal candidate threshold levels. We obtain and show the equivalence of the continuous/smooth fit condition and the firstorder condition for maximization over threshold levels. As examples of its applications, we give a short proof of the McKean optimal stopping problem (perpetual American put option) and solve an extension to Egami and Yamazaki [26].
An ODE approach for the expected discounted penalty at ruin in a jumpdiffusion model,” Finance and Stochastics 11
, 2007
"... For a general penalty function, the expected discounted penalty at ruin was considered by, for example, Gerber and Shiu(1998) and Gerber and Landry (1998) in insurance literature. On the other hand, many pricing functionals in mathematical finance(e.g., options pricing, credit risk modelling) can be ..."
Abstract

Cited by 7 (2 self)
 Add to MetaCart
For a general penalty function, the expected discounted penalty at ruin was considered by, for example, Gerber and Shiu(1998) and Gerber and Landry (1998) in insurance literature. On the other hand, many pricing functionals in mathematical finance(e.g., options pricing, credit risk modelling) can be formulated in terms of expected discounted penalties. Under the assumption that the asset value follows a jump diffusion, we show the expected discounted penalty satisfies a homogeneous ODE. Based on ODE theory, we obtain a general form for the expected discounted penalty. In particular, if only downward phasetype jumps are allowed, we obtain an explicit formula in terms of the penalty function. On the other hand, if downward jump distribution is a mixture of exponential distributions (and upward jumps are determined by a general Lévy measure), we obtain closed form solutions for the expected discounted penalty. For earlier and related results, see Gerber and Landry(1998), Hilberink and Rogers(2002), Mordecki(2002), Kou and Wang(2004), Asmussen et al.(2004) and others. Key words: jump diffusion, integrodifferential equation, expected discounted penalty, phasetype distribution
M.: Double exponential jump diffusion process: A structural model of endogenous default barrier with rollover debt structure, preprint, Université d
, 2006
"... In this paper, we extend the framework of Leland (1994b) who proposed a structural model of rollover debt structure in a BlackScholes framework to the case of a double exponential jump diffusion process. We consider a tradeoff model with firm’s parameters as firm risk, riskfree interest rate, pay ..."
Abstract

Cited by 4 (0 self)
 Add to MetaCart
(Show Context)
In this paper, we extend the framework of Leland (1994b) who proposed a structural model of rollover debt structure in a BlackScholes framework to the case of a double exponential jump diffusion process. We consider a tradeoff model with firm’s parameters as firm risk, riskfree interest rate, payout rate as well as tax benefit of coupon payments, default costs, violation of the absolute priority rule and tax rebate. We obtain the equity, debt, firm and credit spreads values in closed form formulae. We analyze these values as functions of coupon, leverage and maturity.
PRECAUTIONARY MEASURES FOR CREDIT RISK MANAGEMENT IN JUMP MODELS
, 2010
"... Sustaining efficiency and stability by properly controlling the equity to asset ratio is one of the most important and difficult challenges in bank management. Due to unexpected and abrupt decline of asset values, a bank must closely monitor its net worth as well as market conditions, and one of it ..."
Abstract

Cited by 4 (3 self)
 Add to MetaCart
Sustaining efficiency and stability by properly controlling the equity to asset ratio is one of the most important and difficult challenges in bank management. Due to unexpected and abrupt decline of asset values, a bank must closely monitor its net worth as well as market conditions, and one of its important concerns is when to raise more capital so as not to violate capital adequacy requirements. In this paper, we model the tradeoff between avoiding costs of delay and premature capital raising, and solve the corresponding optimal stopping problem. In order to model defaults in a bank’s loan/credit business portfolios, we represent its net worth by appropriate Lévy processes, and solve explicitly for the double exponential jump diffusion process. In particular, for the spectrally negative case, we generalize the formulation using the scale function, and obtain explicitly the optimal solutions for the exponential jump diffusion process.
Rethinking Dynamic Capital Structure Models with RollOver Debt,” Mathematical Finance forthcoming
, 2012
"... Abstract Dynamic capital structure models with rollover 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 link ..."
Abstract

Cited by 4 (0 self)
 Add to MetaCart
Abstract Dynamic capital structure models with rollover 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.