Modeling of Contingent Capital Under a Double Exponential JumpDiffusion Model with Switching Regime

Abstract

This paper discusses a theoretical explanation that relies on investment within the framework of a regime-switching structural model whose investment cost is financed by equity and CoCos. The unexpected return of the project is governed by a continuous and temporal Markov chain. Explicit solutions have been proposed under a regime-switching structural model when the value of the cash flows generated by the firm follows a double-exponential step-distribution diffusion process. The equilibrium price theory under the jump diffusion model was developed using the structural model introduced by Leland (1994) and later extended by Kou (2002) and Chen and Kou (2009). The study focused on the influence of contingent convertibles on investment and financing policies and the inefficiencies related to debt overhang and asset substitution in the presence of an investment option

Keywords

• Contingent capital
• Jump-diffusion model
• Credit risk
• Real option