FIN-03-014 |
NYU Stern School of Business |
February 2003
Jing-zhi Huang, Nengjiu Ju, and Hui Ou-Yang
ABSTRACT
This paper develops a model of optimal capital structure with stochastic interest
rate which is assumed to follow a mean-reverting process. Closed-form solutions
are obtained for both the value of the firm and the value of its risky debt.
The paper finds that the current level and the long-run mean of the interest
rate process play distinctive roles in our integrated model. The current level
of the interest rate is critical in the pricing of risky bonds, while the long-run
mean plays a key role in the determination of a firm’s optimal capital sucture
such as the optimal coupon rate and leverage ratio. Our findings demonsate that
a model of optimal capital sucture with a constant interest rate cannot price
risky bonds and determine the optimal capital sucture simultaneously in a satisfactory
manner. Furthermore, our numerical results indicate that the correlation between
the stochastic interest rate and the asset return of a firm has little impact
on the firm’s optimal capital sucture.
Jing-zhi Huang
Institution: Stern School of Business, New York University, 44 West 4th Seet, New York, NY 10012
Telephone: (212) 998-0300
Fax: (212) 995-4233
Email: jhuang0@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~jhuang0
Nengjiu Ju
Institution: Smith School of Business, University of Maryland, College Park, MD 20742
Telephone: (301) 405-2934
Email: nju@rhsmith.umd.edu
Hui Ou-Yang
Institution: Fuqua School of Business, Duke University, Durham, NC 27708-0120
Telephone: (919) 660-3790
Email: huiou@duke.edu
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