A dynamic program for valuing corporate securities

A dynamic program for valuing corporate securities

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Article ID: iaor201530460
Volume: 249
Issue: 2
Start Page Number: 751
End Page Number: 770
Publication Date: Mar 2016
Journal: European Journal of Operational Research
Authors: , ,
Keywords: programming: dynamic, finance & banking
Abstract:

We design and implement a dynamic program for valuing corporate securities, seen as derivatives on a firm’s assets, and computing the term structure of yield spreads and default probabilities. Our setting is flexible for it accommodates an extended balance‐sheet equality, arbitrary corporate debts, multiple seniority classes, and a reorganization process. This flexibility comes at the expense of a minor loss of efficiency. The analytical approach proposed in the literature is exchanged here for a quasi‐analytical approach based on dynamic programming coupled with finite elements. To assess our construction, which shows flexibility and efficiency, we carry out a numerical investigation along with a complete sensitivity analysis.

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