The Decision Model of Extending a Defaulting Debt
Date Issued
2009
Date
2009
Author(s)
Chung, Yi-Fang
Abstract
This paper uses the traditional Black-Scholes-Merton structural model to discuss the strategic choices faced by the special risk exposure considering creditor when deciding whether to grant maturity extension on a defaulted loan. The objective function of the model described in this paper is to compare the modified Sharpe ratio before and after maturity extension. This paper finds that the revised decision model with the Sharpe ratio has these compelling characteristics: (1)It ensures that the expected modified Sharpe ratio is higher after maturity extension than before; (2)It recognizes that changes in the risk profile of the firm before and after maturity extension substantially affect the strategic behavior of the special risk exposure considering creditor; (3)It demonstrates the effects of profit sharing plans provided to the special risk exposure considering creditor by the stockholder of the firm, where the higher the profit sharing percentage the creditor get, the more willing it will be to extend maturity.
Subjects
extendible bond
defaulting debt
Sharpe ratio
Type
thesis
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