Contingent Claims Analysis of Valuation of Risky Debt with Bankruptcy Costs
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Abstract:
Research on valuation of corporate risky debt is given when bankruptcy costs are taken into account. Bankruptcy costs are expenditures of enterprise that get into bankruptcy, as a result, enterprise asset value is reduced, and debt value is reduced too because bondholders only receive asset value deducted from bankruptcy costs. Differential equation which risky debt value follows is given and a model about infinite maturity debt is obtained. By applying contingent claims pricing and stochastic calculus methods, the paper derives a risky debt value formula, this formula can illustrate the effect of investment policy and dividend policy on risky debt value. At last the results are comporred with results of Merton and Black and it is found that our results improve Merton and Black's.
