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The Effect of Interest Rates on the Value of Corporate Assets and the Risk Premia of Corporate Debt

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  • Lesseig, Vance P
  • Stock, Duane

Abstract

A growing number of papers have applied option pricing techniques to the valuation of risky debt. This paper deals directly with how a firm's relationship to interest rates affects its debt. A sequential binomial model is used to price the zero-coupon bonds of a firm whose value is related to interest rate changes. The results show that the strength of the relationship between firm value and interest rates (interest-rate risk) can have a significant impact on the value of a firm's debt. The model produces its most powerful results when the volatility of firm value is high and the term structure has a steep (negative or positive) slope; there is no impact when the term structure is flat. Our results indicate that empirical studies of yield spreads may have severe shortcomings if the relationship of firm value to interest rate changes is ignored. Copyright 1998 by Kluwer Academic Publishers

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  • Lesseig, Vance P & Stock, Duane, 1998. "The Effect of Interest Rates on the Value of Corporate Assets and the Risk Premia of Corporate Debt," Review of Quantitative Finance and Accounting, Springer, vol. 11(1), pages 5-22, July.
    • Handle: RePEc:kap:rqfnac:v:11:y:1998:i:1:p:5-22
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    Cited by:

    1. Chuang-Chang Chang & Jun-Biao Lin & Chun-Chieh Yang, 2015. "The effect of stochastic interest rates on a firm’s capital structure under a generalized model," Review of Quantitative Finance and Accounting, Springer, vol. 45(4), pages 695-719, November.
    2. Cathy Yi-Hsuan Chen & Thomas C. Chiang, 2017. "Surprises, sentiments, and the expectations hypothesis of the term structure of interest rates," Review of Quantitative Finance and Accounting, Springer, vol. 49(1), pages 1-28, July.

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