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Extend the debt as it is not deeply out-of-the-money

Author

Listed:
  • Wei-Hsiung Wu

    (Department of Finance, Ming Chuan University)

  • Hui-Hwang Tsai

    (Graduate School of Department of Finance, National Taiwan University)

  • Shyan-Yuan Lee

    (Department of Finance, National Taiwan University)

  • Son-Nan Chen

    (Department of Banking and Finance, National Chengchi University)

Abstract

In this paper, we modify the extendible debts model proposed in Longstaff (1990) to help relieve the moral hazard problem induced in the original model. In Longstaff¡¦s model, extending the maturity of the defaulted debts gives the borrower an incentive to default even if the borrower is insolvent. In this paper, we argue that the debt should not be extended if it is defaulted severely. We have shown that the extendible debt valuation can be obtained by the compound option pricing besides the PDE approach. We also have derived the fair interest rate of the extendible debts in this paper.

Suggested Citation

  • Wei-Hsiung Wu & Hui-Hwang Tsai & Shyan-Yuan Lee & Son-Nan Chen, 2008. "Extend the debt as it is not deeply out-of-the-money," Economics Bulletin, AccessEcon, vol. 7(16), pages 1-6.
    • Handle: RePEc:ebl:ecbull:eb-08g00022
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    Cited by:

    1. Moraux, Franck & Navatte, Patrick, 2015. "How do reservation prices impact distressed debt rescheduling?," Economic Modelling, Elsevier, vol. 46(C), pages 269-282.
    2. Wu, Wei-Hwa, 2021. "Extendible stock loan," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).

    More about this item

    JEL classification:

    • G0 - Financial Economics - - General
    • G2 - Financial Economics - - Financial Institutions and Services

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