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Valuing Debt in a Complex Capital Structure

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  • Riddiough, Timothy J
  • Thompson, Howard E

Abstract

This article extends previous bond valuation models to account for more realistic assumptions regarding financial distress. Realized value of an individual bond under severe financial distress will reflect the expected outcome of credit-event negotiations and the relative priority listing of the security. We explicitly represent the probability rate of credit-event occurrence as a function of firm value relative to the fixed overall debt obligations of the firm. Risk premiums generated under reasonable parameter value choices fall within the range of observed bond risk premiums. Our model also provides an explanation as to why observed bond risk premia are positive after adjustment for default. Copyright 1996 by Kluwer Academic Publishers

Suggested Citation

  • Riddiough, Timothy J & Thompson, Howard E, 1996. "Valuing Debt in a Complex Capital Structure," Review of Quantitative Finance and Accounting, Springer, vol. 6(3), pages 203-221, May.
    • Handle: RePEc:kap:rqfnac:v:6:y:1996:i:3:p:203-21
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    Cited by:

    1. Sudipto Sarkar & Chuanqian Zhang, 2016. "Loan-commitment borrowing and performance-sensitive debt," Review of Quantitative Finance and Accounting, Springer, vol. 47(4), pages 973-986, November.
    2. Pyo, Unyong & Thompson, Howard E., 2007. "Bond prices in a debt priority structure with absolute priority rule deviation," The Quarterly Review of Economics and Finance, Elsevier, vol. 47(1), pages 113-134, March.
    3. Oleg Sokolinskiy, 2019. "Debt rollover-induced local volatility model," Review of Quantitative Finance and Accounting, Springer, vol. 52(4), pages 1065-1084, May.

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