Dynamic debt with intensity-based models

Abstract

This article proposes a dynamic debt model where the face value of debt can change. In particular, our dynamic debt setting allows debt changes ruled by intensity processes that are linked to the firm value through the correlation between the stochastic processes. Analytical solutions are obtained, and we extend the proposed dynamic debt model to the case of subordinated debt. While empirical behaviors are emulated, the impacts of dynamic debt over the credit spreads are explored. In this model, the possibility of debt increases magnifies credit spreads and the reverse occurs for the possibility of debt decreases.