A structural model of corporate bond pricing with co-ordination failure

Publication Date
Financial Markets Group Discussion Papers DP 410
Publication Authors

It has been suggested (Morris, Shin 2001) that co-ordination failure be- tween bondholders could produce an effect that would explain the systematic mispricing of corporate debt produced by the Merton (1974) frame- work. In essence, fear of premature foreclosure by other debtors can lead to pre-emptive action, lowering the value of debt. This paper presents a continuous-time bond pricing model integrating this effect, and shows that co-ordination failure can indeed cause bonds to be traded at a discount.