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on Corporate Finance |
| By: | Ethan Cohen-Cole |
| Abstract: | This paper presents a structural debt valuation model that links default probabilities and recovery rates of corporate securities to asset market liquidity. This linking is advantageous for risk management and regulation of financial institutions in that it provides a method of calibrating the relationship between probability of default (PD) and loss given default (LGD). Two innovations in the paper are the placing of the default point in a model of debt valuation into general equilibrium and conditioning this point on market factors such as asset liquidity. These allow one to derive implications on the correlation between various components of the model. Specifically, it finds two relationships between the probability of default (PD) and loss given default (LGD) of a debt instrument; temporal correlations are positive and cross-sectional ones negative. Such findings confirm the intuition of existing reduced form approaches and provide the ability to inspect other properties of the relationship that derive from theory. For example, one can use the model to forecast LGD. Some empirical validation of the theoretical results is provided. |
| Keywords: | Securities ; Default (Finance) |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedbqu:qau07-5&r=cfn |
| By: | Cristina Arellano; Yan Bai; Jing Zhang |
| Abstract: | This paper studies how the degree of contract enforcement in a country influences firms’ financing decisions. We first document empirical facts on debt financing for two new firm-level datasets in the United Kingdom and Ecuador. In the United Kingdom, small firms borrow more relative to their assets than large firms, whereas in Ecuador small firms borrow less. We build a dynamic model of firms’ debt financing where debt is constrained by the likelihood of default, which varies across firms and economies with different degrees of enforcement. Because of their low firm values, small firms are mostly affected by abundance or scarcity of economy-wide loans generated by weak or strong contract enforcement. We calibrate our model to the datasets in the two countries and find that our mechanism can quantitatively account for the patterns observed in the data. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedmsr:392&r=cfn |
| By: | Missaka Warusawitharana |
| Abstract: | Purchases and sales of operating assets by firms generated $162 billion for shareholders over the past 20 years. This contrasts sharply with the evidence on mergers. This paper characterizes the behavior of value-maximizing firms, which may grow organically, purchase existing assets or sell assets. The approach yields an endogenous selection model that links asset purchases and sales to fundamental properties of the firm. Empirical tests confirm the predictions of the model. In particular, return on assets and size strongly predict when firms purchase or sell assets, and the transaction size covaries with the value of capital employed by the firm. These findings indicate that corporate asset purchases and sales are consistent with efficient investment decisions. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2007-27&r=cfn |