Single and Double Black–Cox: Two approaches for modelling debt restructuring

Abstract

In this paper we propose two first-passage-time approaches for pricing debt and equity when the firm is able to restructure its debt as an alternative to liquidation. In contrast to other first passage models that account for reorganization, our approaches allow the firm to restructure its debt by changing its maturity and/or its face value. The first approach developed consists of a first-passage model for reorganization together with a Merton approach for default, while the second approach uses first-passage models for both reorganization and default. We also provide a comparison of the proposed approaches with the Merton (Merton, R.C., 1974. On the pricing of corporate debt: The risk structure of interest rates. Journal of Finance, 29, 449–470.) and Black and Cox (Black, F. and Cox, J.C., 1976, Valuing corporate securities: Some effects of bond indenture provisions. Journal of Finance, 31, 351–367.) models.