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Debt maturity and endogenous default with optimal stopping theory

Stephane Villeneuve (University of Toulouse)
We focus on corporate models in which debt maturity is modeled in the vein of Leland and Leland and Toft. We point out that these corporate models restrict the set of available bankruptcy policies to hitting times. We write the equity-holders’ bankruptcy problem as a general optimal stopping problem that we solve. We show that restricting bankruptcy policies to hitting times may lead to a dramatic underestimation of the value of equity especially for short term debt.

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