[Nonlinearity is an important consideration in many problems of finance and economics, such as pricing securities and solving equilibrium models. This article provides analytical treatment of a general class of nonlinear transforms for processes with tractable conditional characteristic functions. We extend existing results on characteristic function-based transforms to a substantially wider class of nonlinear functions while maintaining low dimensionality by avoiding the need to compute the density function. We illustrate the applications of the generalized transform in pricing defaultable bonds with stochastic recovery. We also use the method to analytically solve a class of general equilibrium models with multiple goods and apply this model to study the effects of time-varying labor income risk on the equity premium.]

[We develop a dynamic incomplete-markets model of entrepreneurial firms, and demonstrate the implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. We characterize the optimal capital structure via a generalized tradeoff model where risky debt provides significant diversification benefits. Nondiversifiable risks have several important implications: More risk-averse entrepreneurs default earlier, but choose higher leverage; lack of diversification causes entrepreneurial firms to underinvest relative to public firms, and risky debt partially alleviates this problem; and entrepreneurial risk aversion can overturn the risk-shifting incentives induced by risky debt. We also analytically characterize the idiosyncratic risk premium.]

– Since corporate debt tends to be riskier in recessions, transfers from equity holders to debt holders that accompany corporate decisions also tend to concentrate in recessions. Such systematic risk exposures of debt overhang have important implications for corporate investment and financing decisions, and for the ex ante costs of debt overhang. Using a calibrated dynamic capital structure model, we show that the costs of debt overhang become higher in the presence of macroeconomic risk. We also provide several new predictions on how the cyclicality of a firm’s assets in place and growth options affect its investment and capital structure decisions.

A buyer suggests prices to N sellers in a time period and buys from the seller who accepts the bid first. The number of bidding rounds is determined by how frequently the buyer can make an offer. We show that with no limit on the frequency and without discounting, the price path is either kept flat initially with large jumps at the end or increasing steadily over time. Which class of path occurs in equilibrium depends on the buyer's trade-off between committing to a price ceiling versus finely screening the sellers' costs. With discounting, limiting the number of rounds mitigates the delay caused by the reluctance to raise bids in the first class of equilibrium and therefore can benefit the buyer. This result suggests why, in reality, bargaining parties often take measures to make their offers rigid and consequently force themselves to make fewer offers.

[Risks of rare economic disasters can have a large impact on asset prices. At the same time, difficulties in inference regarding both the likelihood and severity of disasters, as well as agency problems, can lead to significant disagreements among investors about disaster risk. We show that such disagreements generate strong risk-sharing motives, such that just a small number of optimists in the economy will significantly reduce the disaster risk premium. Our model highlights the "latent" nature of disaster risk. The disaster risk premium will likely be low and smooth during normal times but increases dramatically when the risk-sharing capacity of the optimists is reduced, e.g., following a disaster. The model also helps reconcile the difference in the amount of disaster risk implied by financial markets and international macroeconomic data, and provides caution to the approach of extracting disaster probabilities from asset prices, which will disproportionately reflect the beliefs of a small group of optimists. Finally, our model predicts an inverse U-shaped relation between the equity premium and the size of the disaster insurance market.]

ABSTRACT I build a dynamic capital structure model that demonstrates how business cycle variation in expected growth rates, economic uncertainty, and risk premia influences firms' financing policies. Countercyclical fluctuations in risk prices, default probabilities, and default losses arise endogenously through firms' responses to macroeconomic conditions. These comovements generate large credit risk premia for investment grade firms, which helps address the credit spread puzzle and the under‐leverage puzzle in a unified framework. The model generates interesting dynamics for financing and defaults, including market timing in debt issuance and credit contagion. It also provides a novel procedure to estimate state‐dependent default losses.

We develop a structural credit model to examine how interactions between default and liquidity affect corporate bond pricing. The model features debt rollover and bond-price-dependent holding costs. Over the business cycle and in the cross-section, the model matches average default rates and credit spreads in the data, and captures variations in bid-ask and bond-CDS spreads. A structural decomposition reveals that default-liquidity interactions can account for 10%–24% of the level of credit spreads and 16%–46% of the changes in spreads over the business cycle. Further, liquidity-related corporate bond financing costs amount to 6% of the total issuance amount from 1996 to 2015.

Abstract We study a publicly traded firm that cares about its short-term stock market performance while collaborating with a privately owned firm in a business alliance. The firms each undertake a relation-specific investment and then bargain over the allocation of the joint surplus generated by the alliance. The public firm’s myopic market concerns affect both the total size of the surplus and how the firms divide the surplus. While the public firm always becomes more aggressive and obtains more of the surplus, the total size of the surplus may become larger or smaller, due to the effect of myopic market concerns on the firms’ investment incentives. We establish conditions under which the investment and the value of each firm increase or decrease with market concerns. The market concerns could mitigate or exacerbate the hold-up problem between the two firms and thus could either benefit or harm the whole business alliance. We also study two extensions with (i) the two investments being substitutes instead of complements and (ii) both firms being publicly listed. In both cases, the insights from our main model still hold.

ABSTRACT We examine the evolution of accounting regulation by linking disclosure policies and investments in a dynamic voting model. The disclosure policies are the outcome of voting by entrepreneurs, whose preferences are influenced by their investments. The investments are in turn endogenously determined by current and future disclosure policies. Absent external influences, accounting regimes are stable. A disclosure regime of high (low) quality and a strong (weak) economy coexist and reinforce each other. However, regulatory interventions can result in regime changes by changing the entrepreneurs’ expectations, even without direct enforcement. Unexpected shocks could also result in regime changes by impacting economic conditions and hence voter composition. Our analysis provides a framework to study the interaction between accounting regulation and firms’ economic decisions.