Optimal Capital Structure under Stochastic Interest Rates with Endogenous Default Barriers

Abstract

Based on the principle of maximization of the utility value for shareholders, we establish an optimal capital structure model under stochastic interest rates with improved endogenous default barriers by considering the tax and bankruptcy risk. From the numerical results, we find the drift and volatility of the firm’s log return, the average risk aversion of all the shareholders, the long term mean level of interest rate and the bond maturity are the key variables in determining optimal capital structure. We also find that the utility values behave as a concave function with bond principals. We can conclude that there exists an optimal amount of bond issuance to maximize the utility value of shareholders.