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A general method for valuing complex capital structures

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  • Borochin, Paul
  • Kopeliovich, Yaacov
  • Shea, Kevin

Abstract

We develop a numerical method based on the Cox et al. (1979) binomial tree option valuation approach that can accommodate arbitrarily complex capital structures with varying debt maturities and seniorities, as well as preferred stock and warrants. The method provides straightforward valuation for common bond market features such as convertibility and prepayment options, as well as sinking fund provisions, that have proven challenging to model analytically.

Suggested Citation

  • Borochin, Paul & Kopeliovich, Yaacov & Shea, Kevin, 2020. "A general method for valuing complex capital structures," Finance Research Letters, Elsevier, vol. 35(C).
    • Handle: RePEc:eee:finlet:v:35:y:2020:i:c:s1544612319303277
    DOI: 10.1016/j.frl.2019.101304
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    References listed on IDEAS

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    1. Geske, Robert & Johnson, H. E., 1984. "The Valuation of Corporate Liabilities as Compound Options: A Correction," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(2), pages 231-232, June.
    2. Leland, Hayne E & Toft, Klaus Bjerre, 1996. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Journal of Finance, American Finance Association, vol. 51(3), pages 987-1019, July.
    3. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    4. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    6. Broadie, Mark & Kaya, Özgür, 2007. "A Binomial Lattice Method for Pricing Corporate Debt and Modeling Chapter 11 Proceedings," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(2), pages 279-312, June.
    7. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. Kim, Hwa-Sung, 2023. "Forced conversion to Chapter 7 bankruptcy and optimal financial decisions," Finance Research Letters, Elsevier, vol. 54(C).

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    More about this item

    Keywords

    Capital structure; Binomial trees; Derivatives pricing;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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