Abstract

This study theoretically examines the probability distribution of corporate bankruptcy upon new debt issuances. We develop a relatively simple Markov model with three feasible corporate phases, derive the stochastic transition rates and the time-related probabilities to remain in each business cycle, and further simulate realistic corporate paths. We find that when both corporate debt and assets are stochastic, the probability to be in Chapter 11 is generally lower among borrowers that portray higher debt variability. Moreover, we detect that the most probable time to be in bankruptcy occurs within two or three years of a new debt issuance.

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