Credit risk and asymmetric information: A simplified approach

We present a simple model for risky, corporate debt. Debtholders and equityholders have incomplete information about the financial state of the debt issuing company. Information is incomplete because it is delayed for all agents, and it is asymmetrically distributed between debtholders and equityholders. We solve for the equityholders' optimal default policy and for the credit spreads required by debtholders. Delayed information accelerates the equityholders' optimal decision to default. Interestingly, this effect is small, implying only a small impact on credit spreads. Asymmetric information, however, has a major impact on credit spreads. Our model predicts high credit spreads for short-term debt, as observed empirically in credit markets.

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