We present a prediction model to forecast corporate defaults. In a theoretical model, under incomplete information in a market with publicly traded equity, we show that our approach must outperform ratings, Altman’s Z-score, and Merton’s distance to default. We reconcile the statistical and structural approaches under a common framework, i.e., our approach nests Altman’s and Merton’s approaches as special cases. Empirically, we cannot reject the superiority of our approach.Furthermore, the numbers of observed defaults align well with the estimated probabilities. Finally, with rank transforms, we obtain cycle-adjusted forecasts that still outperform ratings.
We identify and characterize a class of term structure models where bond yields are quadratic functions of the state vector. We label this class the quadratic class and aim to lay a solid theoretical foundation for its future empirical application. We consider asset pricing in general and derivative pricing in particular under the quadratic class. We provide two general transform methods in pricing a wide variety of fixed income derivatives in closed or semi-closed form. We further illustrate how the quadratic model and the transform methods can be applied to more general settings.
We estimate the impact of bank merger announcements on borrowers' stock prices for publicly traded Norwegian firms. Borrowers of target banks lose about 0.8% in equity value, while borrowers of acquiring banks earn positive abnormal returns, suggesting that borrower welfare is influenced by a strategic focus favoring acquiring borrowers. Bank mergers lead to higher relationship exit rates among borrowers of target banks. Larger merger-induced increases in relationship termination rates are associated with less negative abnormal returns, suggesting that firms with low switching costs switch banks, while similar firms with high switching costs are locked into their current relationship
When information is costly, a seller may wish to prevent prospective buyers from acquiring information, for the cost of information acquisition ultimately is borne by the seller. A seller can achieve the desired prevention through posted-priceselling, by offering prospective buyers a discount. No such prevention is possible in the case of an auction. We establish the result that the seller prefers posted-priceselling when the cost of information acquisition is high andauctions when it is low. We view corporatebonds as an instance of the former case, andgovernmentbonds as an instance of the latter.
We analyze the role of knowhow acquisition in the formation and duration of joint ventures. Two parties become partners in a joint venture to benefit from each other’s knowhow. Joint operations provide each party with the opportunity to acquire part of its partner’s knowhow. A party’s increased knowhow provides the impetus for the dissolution of the joint venture. We characterize the conditions under which dissolution takes place, identify the party that buys out its partner, determine the time to dissolution, establish its comparative statics, and examine the implications of knowledge acquisition for the desirability of joint venture formation.
Shareholder agreements govern the relations among shareholders in privately held firms, such as joint ventures and venture capital-backed companies. We provide an economic explanation for key clauses in such agreements 14namely, put and call options, tag-along and drag-along rights, demand and piggy-back rights, and catch-up clauses. In a dynamic moral hazard setting, we show that these clauses can ensure that the contract parties make efficient ex ante investments in the firm. They do so by constraining renegotiation. In the absence of the clauses, ex ante investment would be distorted by unconstrained renegotiation aimed at (i) precluding value-destroying ex post transfers, (ii) inducing value-increasing ex post investments, or (iii) precluding hold-out on value-increasing sales to a trade buyer or the IPO market.
We propose a new modeling framework to study the asset pricing implications of learning under ambiguity aversion. In a continuous time partial information Lucas economy, we characterize analytically equilibrium equity returns and make the following observations. First, learning under ambiguity aversion implies an equilibrium discount for ambiguity, if and only if relative risk aversion is below one or, equivalently, the elasticity of intertemporal substitution (EIS) is above one. In this case, ambiguity aversion increases conditional equity premia and volatilities. Second, equilibrium interest rates are lower, irrespective of risk aversion. Third, no time-invariant relation between excess returns and conditional variances exists. Therefore, estimated relations between excess returns and equity conditional variances are highly time varying and have an indeterminate sign. Fourth, estimates of the EIS based on standard Euler equations for equity returns are strongly downward biased in a setting of learning and ambiguity aversion. Therefore, an EIS well above one can be consistent with estimates of EIS well below one. Fifth, ambiguity does not resolve asymptotically. Finally, using realistic model parameters, we show that a low risk aversion and a moderate amount of ambiguity are consistent with the equity premium, the low interest rate, and the excess volatility puzzles.
This paper studies loan conditions when firms switch banks. Recent theoretical work on bank–firm relationships motivates our matching models. The dynamic cycle of the loan rate that we uncover is as follows: a loan granted by a new (outside) bank carries a loan rate that is significantly lower than the rates on comparable new loans from the firm's current (inside) banks. The new bank initially decreases the loan rate further but eventually ratchets it up sharply. Other loan conditions follow a similar economically relevant pattern. This bank strategy is consistent with the existence of hold-up costs in bank–firm relationships.
We study a continuous-time principal–agent model in which a risk-neutral agent withlimited liability must exert unobservable effort to reduce the likelihood of large but rel- atively infrequent losses. Firm size can be decreased at no cost or increased subject to adjustment costs. In the optimal contract, investment takes place only if a long enough period of time elapses with no losses occurring. Then, if good performance continues, the agent is paid. As soon as a loss occurs, payments to the agent are suspended, and so is investment if further losses occur. Accumulated bad performance leads to downsiz- ing. We derive explicit formulae for the dynamics of firm size and its asymptotic growth rate, and we provide conditions under which firm size eventually goes to zero or grows without bounds.KEYWORDS: Principal–agent model, limited liability, continuous time, Poisson risk, downsizing, investment, firm size dynamics.
