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The expected cost of default

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  • Glover, Brent

Abstract

The sample of observed defaults significantly understates the average firm׳s true expected cost of default due to a sample selection bias. I use a dynamic capital structure model to estimate firm-specific expected default costs and quantify the selection bias. The average firm expects to lose 45% of firm value in default, a cost higher than existing estimates. However, the average cost among defaulted firms in the estimated model is only 25%, a value consistent with existing empirical estimates from observed defaults. This substantial selection bias helps to reconcile the levels of leverage and default costs observed in the data.

Suggested Citation

  • Glover, Brent, 2016. "The expected cost of default," Journal of Financial Economics, Elsevier, vol. 119(2), pages 284-299.
    • Handle: RePEc:eee:jfinec:v:119:y:2016:i:2:p:284-299
    DOI: 10.1016/j.jfineco.2015.09.007
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    More about this item

    Keywords

    Default costs; Structural estimation; Costs of financial distress; Dynamic capital structure;
    All these keywords.

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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