I build a dynamic capital structure model that demonstrates how business-cycle variations in expected growth rates, economic uncertainty, and risk premia influence firms' financing and default policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise...

Since 2002, spreads on emerging market sovereign debt have fallen to historical lows. Given the close links between sovereign spreads, capital flows to emerging markets, and economic growth, understanding the factors driving these spreads is very important. We address this issue in two stages....

What is an optimal or a sustainable external debt - for a country, region or sector? How should one monitor and evaluate debt to preclude a crisis? We use stochastic optimal control/dynamic programming to derive an optimal debt. The deviation of the actual from the optimal will serve as a...

Recent empirical studies show that innovative firms heavily rely on debt financing. Debt overhang implies that debt hampers investment by incumbents. We show that a second effect of debt is that it stimulates entry of new firms and, therefore, innovation. Using a Schumpeterian growth model in...

We propose a unified explanation for two seemingly disparate empirical findings: the negative abnormal returns of distressed stocks, and of small growth stocks. Based on a counterintuitive result relating option prices to jump risk (Merton 76), we show via an investment valuation model that...

We propose a unified explanation for two seemingly disparate empirical findings: the negative abnormal returns of distressed stocks, and of small growth stocks. Based on a counterintuitive result relating option prices to jump risk (Merton (1976)), we show via an investment valuation model that...

Since the early 2000s liquidity in option markets has become less resilient, and our evidence suggests that it is so because of an increased vulnerability to liquidity shocks in the underlying. To demonstrate the causal impact, we consider an incident in which a large broker dealer erroneously...

This paper shows that firm growth potential – representing a firm's yet-unexercised growth opportunities – is associated with option overpricing and low future delta-hedged option returns. We provide an explanation of this phenomenon based on the idea that retail investors exert buying...