Abstract
In this research letter, we introduce a version of a CoCo bond to construct a new model for dynamically adjusting a firm’s leverage. The resulting leverage dynamic allows keeping the issuer’s leverage ratio within some predetermined boundaries where the likelihood of default on outstanding liabilities remains small and, at the same time, ensures the firm’s financial efficiency through a reissuance feature, when the leverage reaches too low levels. Different control actions are studied in this scope, since none requires external intervention, they act as a ‘watchdog’, ensuing in a self-adaptive debt-to-assets ratio. The model exhibits interesting mean-reverting properties and is notably suitable for the analysis of a real firm’s behavior.
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