Continuous Time Models in Corporate Finance Banking and Insurance 1st edition by Santiago, Jean Charles 0691176523 9780691176529

1 Why Is Option Pricing Useful in Corporate Finance?

1.1 Modeling assumptions

1.2 Pricing corporate debt

1.3 Endogenous default date

1.3.1 The general form of the valuation equation

1.3.2 The price of a consol bond

1.4 Dynamic trade-off theory

1.4.1 Taxes and liquidation costs

1.4.2 Asset pricing

1.4.3 Financial decisions

1.4.4 Testable predictions

1.5 Further reading

2 The Base Liquidity-Management Model

2.1 The dynamics of net earnings

2.2 Risk-averse shareholders

2.2.1 Shareholder value

2.2.2 The optimal dividend flow

2.2.3 The value function

2.3 Risk-neutral shareholders

2.3.1 The dynamics of liquid reserves and the value function

2.3.2 The optimal dividend-distribution strategy

2.3.3 Economic implications

2.4 Further reading

3 Equity Issuance

3.1 Fixed issuance cost and stock-price dynamics

3.1.1 Optimal equity issuance with a fixed issuance cost

3.1.2 The impact of equity-issuance on the value function

3.1.3 When is equity issuance too costly?

3.1.4 Stock-price dynamics

3.2 Proportional issuance cost

3.2.1 The value function with a proportional issuance cost

3.2.2 Characterizing the optimal dividend-distribution barrier

3.2.3 The optimal equity-issuance strategy when the issuance cost is proportional

3.3 Uncertain refinancing opportunities

3.3.1 The cash-reserves dynamics with uncertain refinancing

3.3.2 The amount of uncertain refinancing

3.3.3 The refinancing region and the target cash level

3.4 Further reading

4 Applications to Banking

4.1 A simple continuous-time model of a bank

4.1.1 The model

4.1.2 The impact of a minimum-capital requirement

4.1.3 A minimum-capital requirement with recapitalization

4.2 A bank’s portfolio problem

4.2.1 Setting up the stochastic-control problem

4.2.2 The value function and the first-best

4.3 Optimal bank funding

4.3.1 The model

4.3.2 The optimal funding strategies

4.3.3 Numerical analysis

4.4 Further reading

5 Applications to Insurance

5.1 The base liquidity-management model with large losses

5.1.1 The variational inequality in the presence of large losses

5.1.2 The value function

5.1.3 Computing the value function

5.2 Reinsuring Brownian risks

5.2.1 The dynamics of liquid reserves and the variational inequality

5.2.2 The partial-exposure region

5.2.3 The full-exposure region

5.2.4 Sensitivity analysis

5.3 Reinsuring large losses

5.3.1 The cash-reserves dynamics

5.3.2 The optimal reinsurance strategy

5.4 Further reading

6 Applications to Investment

6.1 The “q-model” of corporate investment

6.1.1 The stock of capital and its productivity

6.1.2 Shareholder value

6.1.3 Tobin’s q

6.2 Introducing external financial frictions

6.2.1 The impact of liquidity constraints on firm value

6.2.2 The size-adjusted value function

6.2.3 Optimal investment and Tobin’s q

6.3 Adopting a new technology

6.3.1 The model

6.3.2 The interaction between investment and dividend payouts

6.3.3 The optimal investment time

6.4 Further reading

7 Agency Frictions

7.1 Asset substitution and capital structure

7.1.1 The model

7.1.2 The risk-shifting problem

7.1.3 The impact of risk shifting on firm value

7.2 Dynamic capital structure

7.2.1 The model

7.2.2 The manager’s continuation utility

7.2.3 The principal’s value function and the optimal contract

7.2.4 Implementing the optimal contract through the firm’s capital structure

7.3 Preventing large risks

7.3.1 The model

7.3.2 The contracting problem

7.3.3 Addressing incentive compatibility

7.3.4 The financiers’ value function

7.3.5 The size-adjusted problem and the optimal contract

7.4 Further reading

8 Equilibrium Models

8.1 The Brunnermeier-Sannikov model

8.1.1 The model

8.1.2 The value function of a financial intermediary

8.1.3 The value function of households and the competitive equilibrium

8.2 An equilibrium version of the base model

8.2.1 The model

8.2.2 Equilibrium

8.2.3 The long-term behavior of the economy

8.3 Insurance cycles

8.3.1 The model

8.3.2 Equilibrium

8.3.3 Dynamics of insurance prices

8.4 Further reading