Pricing of Debt and Equity in a Financial Network with Comonotonic Endowments
Tathagata Banerjee, Zachary Feinstein
Operations Research · 2022 · Volume 70 · Issue 4
Abstract
In this paper, we present formulas for the valuation of debt and equity of firms in a financial network under comonotonic endowments. We demonstrate that the comonotonic setting provides a lower bound and Jensen’s inequality provides an upper bound to the price of debt under Eisenberg-Noe financial networks with bankruptcy costs. Such financial networks encode the interconnection of firms through debt claims. The proposed pricing formulas consider the realized, endogenous recovery rate on debt claims. We endogenously construct the comonotonic endowment setting from an equity maximizing standpoint with capital transfers. We conclude by, numerically, comparing the network valuation problem with two single firm baseline heuristics that can, respectively, approximate the price of debt and equity.
Keywords
Financial Engineering, network valuation, financial networks, default contagion, systemic risk, credit risk
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