Recent Bankruptcy Finance-Related Articles of Interest Available for Downloading from SSRN

The following finance bankruptcy-related papers, arranged by abstract ID number, can be downloaded from the Social Science Research Network:

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Rice University's Evgeny Lyandres and George Mason University's Alexei Zhdanov: "Investment Opportunities and Bankruptcy Prediction." (Abstract ID: 946240)

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Univ. of Minnesota's Timothy J. Kehoe and UCLA's David K. Levine: "Bankruptcy and Collateral in Debt Constrained Markets" (Abstract ID: 940605)

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Univ. of Chicago's Arthur G. Korteweg: "The Costs of Financial Distress across Industries" (Abstract ID: 945425)

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NYU's Edward I. Altman and Brent Pasternack: "Defaults and Returns in the High Yield Bond Market: The Year 2005 in Review and Market Outlook" (Abstract ID: 943326) 

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IKB Deutsche Industriebank AG's Lutz Hahnenstein and Univ. of Regensburg's Klaus Roder: "Who Hedges More When Leverage is Endogenous? A Testable Theory of Corporate Risk Management under General Distributional Conditions" (Abstract ID: 934589)

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 IKB Deutsche Industriebank AG's Lutz Hahnenstein and Univ. of Regensburg's Klaus Roder: "Corporate Hedging and Capital Structure Decisions: Towards an Integrated Framework for Value Creation" (Abstract ID: 934580)

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Univ. of York's Marco Realdon: "Pricing the Credit Risk of Secured Debt and Financial Leasing" (Abstract ID: 934616)

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 IKB Deutsche Industriebank AG's Lutz Hahnenstein and Univ. of Regensburg's Klaus Roder: "The Minimum Variance Hedge and the Bankruptcy Risk of the Firm" (Abstract ID: 934578)

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Abstracts for each of these papers follows:

Evgeny Lyandres and Alexei Zhdanov, "Investment Opportunities and Bankruptcy Prediction." (Abstract ID: 946240):

A firm's mix of growth options and assets in place is an important determinant of its optimal default strategy. Our simple model shows that shareholders of a firm with valuable investment opportunities would be able/willing to wait longer before defaulting on their contractual debt obligations than shareholders of an otherwise identical firm without such opportunities. More importantly, we show empirically using a dataset of recent corporate bankruptcies that measures of investment opportunities are significantly related to bankruptcy. Augmenting existing bankruptcy prediction models by these measures improves their in-sample fit and out-of-sample forecasting ability.

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Timothy J. Kehoe and David K. Levine, "Bankruptcy and Collateral in Debt Constrained Markets" (Abstract ID: 940605):

Typical models of bankruptcy and collateral rely on incomplete asset markets. In fact, bankruptcy and collateral add contingencies to asset markets. In some models, these contingencies can be used by consumers to achieve the same equilibrium allocations as in models with complete markets. In particular, the equilibrium allocation in the debt constrained model of Kehoe and Levine (2001) can be implemented in a model with bankruptcy and collateral. The equilibrium allocation is constrained efficient. Bankruptcy occurs when consumers receive low income shocks. The implementation of the debt constrained allocation in a model with bankruptcy and collateral is fragile in the sense of Leijonhufvud's corridor of stability, however: If the environment changes, the equilibrium allocation is no longer constrained efficient.

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Arthur G. Korteweg, "The Costs of Financial Distress across Industries" (Abstract ID: 945425):

In this paper I estimate the market's opinion of ex-ante costs of financial distress (CFD) from a structural model of the industry, using a panel dataset of monthly market values of debt and equity for 244 firms in 22 industries between 1994 and 2004. Costs of financial distress are identified from the market values and systematic risk of a company's debt and equity. The market expects costs of financial distress to be 0-11% of firm value for observed levels of leverage. In bankruptcy, the costs of distress can rise as high as 31%. Across industries, CFD are driven primarily by the potential for under-investment problems and distressed asset fire-sales, as measured by spending on research and development and the proportion of intangible assets in the firm. There is considerable empirical support for the hypothesis that firms choose a leverage ratio based on the trade-off between tax benefits and costs of financial distress. The results do not confirm the under-leverage puzzle for firms with publicly traded debt.

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 Edward I. Altman and Brent Pasternack, "Defaults and Returns in the High Yield Bond Market: The Year 2005 in Review and Market Outlook" (Abstract ID: 943326): 

Dr. Altman has earned an international reputation as an expert on corporate bankruptcy, high yield bonds, distressed debt and credit risk analysis. In this article, Altman and his team provide a comprehensive review of the 2005 high yield bond market. The article provides detailed long-term analysis of the US market, as well as trends in default, bankruptcy, recovery and returns for investors. Against this historical backdrop, the article offers some guidance on expected default rates and market performance in the burgeoning high-yield distressed bond market.

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Lutz Hahnenstein and Klaus Roder, "Who Hedges More When Leverage is Endogenous? A Testable Theory of Corporate Risk Management under General Distributional Conditions" (Abstract ID: 934589):

This paper develops a theory of a firm´s hedging decision with endogenous leverage. In contrast to previous models in the literature, our framework is based on less restrictive distributional assumptions and allows a closed-form analytical solution to the joint optimization problem. Using anecdotal evidence of greater benefits of risk management for firms selling “credence goods” or products that involve long-term relationships, we prove that those optimally leveraged firms, which face more convex indirect bankruptcy cost functions, will choose higher hedge ratios. Moreover, we suggest a new approach to test this relationship empirically.

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Lutz Hahnenstein and Klaus Roder, "Corporate Hedging and Capital Structure Decisions: Towards an Integrated Framework for Value Creation" (Abstract ID: 934580): 

We suggest a joint optimization model for a firm's hedging and leverage decisions that helps to establish an integrated framework for value creation. Rather than artificially separating the two interrelated parts of the firm's financial policy, we treat both corporate decision variables as endogenous. We argue that exogenous differences between financial distress costs across firms, and particularly across industries, simultaneously influence corporate risk management and capital structure decisions. Using anecdotal evidence, our focus is not on so-called direct bankruptcy costs, but rather on the cross-sectional variation in indirect bankruptcy costs, which may result from a deterioration of relationships with customers, suppliers or other stakeholders prior to the legal act of bankruptcy.

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Marco Realdon, "Pricing the Credit Risk of Secured Debt and Financial Leasing" (Abstract ID: 934616):

This paper presents closed form solutions to price secured bank loans and financial leases subject to default risk. Secured debt fair credit spreads always increase in the debtor's default probability, whereas financial leasing fair credit spreads may well decrease in the lessee's default probability and even be negative. The reason is that the lessor, unlike the secured lender, can gain from the lessee's default, especially when the leasing contract envisages initial prepayments or the lessee's terminal options to either purchase the leased asset or to extend the lease maturity. This result, which critically depends on contractual and bankruptcy code provisions, can explain some of the empirical evidence and the use of financial leases as an alternative to secured bank lending to finance small, risky and relatively opaque firms.

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 Lutz Hahnenstein and Klaus Roder, "The Minimum Variance Hedge and the Bankruptcy Risk of the Firm" (Abstract ID: 934578):

In this paper, we analyze the influence of hedging with forward contracts on the firm's probability of bankruptcy. The minimization of this probability can serve as a substitute for the maximization of shareholders' wealth. It is shown that the popular minimum-variance-hedge is generally neither necessary nor sufficient for the minimization of the firm´s probability of bankruptcy. Moreover, our model suggests a correction of the widespread view that a reduction in the variance of the future value of the firm is inevitably accompanied by a reduction in its default risk. We derive an analytical solution for the variance-minimizing hedge ratio of a firm exposed to both input and output price uncertainty that takes into account the issue of correlation. Based on this solution we provide a graphical analysis to prove our claim that there is a fundamental difference between hedging policies focused on bankruptcy risk and those following conventional wisdom even if positive correlation constitutes a “natural” hedge.

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© Steve Jakubowski 2007