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2004 | Buch | 2. Auflage

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A Game Theory Analysis of Options

Corporate Finance and Financial Intermediation in Continuous Time

verfasst von: Professor Alexandre Ziegler

Verlag: Springer Berlin Heidelberg

Buchreihe : Springer Finance

Enthalten in: Professional Book Archive

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Über dieses Buch

Modern option pricing theory was developed in the late sixties and early seventies by F. Black, R. e. Merton and M. Scholes as an analytical tool for pricing and hedging option contracts and over-the-counter warrants. How ever, already in the seminal paper by Black and Scholes, the applicability of the model was regarded as much broader. In the second part of their paper, the authors demonstrated that a levered firm's equity can be regarded as an option on the value of the firm, and thus can be priced by option valuation techniques. A year later, Merton showed how the default risk structure of cor porate bonds can be determined by option pricing techniques. Option pricing models are now used to price virtually the full range of financial instruments and financial guarantees such as deposit insurance and collateral, and to quantify the associated risks. Over the years, option pricing has evolved from a set of specific models to a general analytical framework for analyzing the production process of financial contracts and their function in the financial intermediation process in a continuous time framework. However, very few attempts have been made in the literature to integrate game theory aspects, i. e. strategic financial decisions of the agents, into the continuous time framework. This is the unique contribution of the thesis of Dr. Alexandre Ziegler. Benefiting from the analytical tractability of contin uous time models and the closed form valuation models for derivatives, Dr.

Inhaltsverzeichnis

Frontmatter

1. Methodological Issues

Abstract

Game Theory is the study of multi-person decision problems. Since its beginnings in the early 20th century and von Neumann’s [86] proof of the minimax theorem, game theory has evolved rapidly and is now a major field of economic theory. It has become a standard part of major economics textbooks and is the main instrument of analysis in some important fields of economics, such as industrial organization, corporate finance and financial intermediation. In spite of this development, in recent years, game theory has faced methodological problems in handling uncertainty and timing decisions in dynamic models. This constitutes a severe limitation for the analysis of strategic issues in financial decision-making, where uncertainty and risk are particularly important.

Alexandre Ziegler

2. Credit and Collateral

Abstract

Moral hazard is a source of inefficiency that has been studied extensively in economics and finance. In financial contracting, both classical forms of moral hazard exist, each giving rise to specific incentive issues:¹

In a situation of hidden action, the agent takes an action that is not observed by the principal. For example, the borrower might try to influence the return distribution of his project to increase his expected payoff at the expense of the lender. This is the so-called risk-shifting or asset substitution problem, which was first laid out by Jensen and Meckling [45].
In contrast, in a situation of hidden information, the agent privately observes the true state of the world prior to choosing an observable action. In the context of financial contracting, the borrower typically is the only person that can observe project returns at no cost. To the extent that his promised payment depends positively on realized project return, he might have an incentive to understate project return in order to reduce his payment to the lender. This form of information asymmetry gives rise to the so-called observability problem, which was addressed in the costly state verification literature in the wave of Townsend’s [85] pathbreaking paper. The main conclusion of this literature is that costly state verification by the principal (lender) makes complete risk-sharing suboptimal.

Alexandre Ziegler

3. Endogenous Bankruptcy and Capital Structure

Abstract

In the simple setting considered in Chap. 2, the lender provided funding to the borrower in order to finance investment in a project which had a finite, known maturity of T. Accordingly, the contract between lender and borrower specified a single payment from the borrower to the lender at time T, with bankruptcy occurring when the borrower was unable to meet his contractual payment obligation. Although such an analysis is valuable for an understanding of project financing, it is much less accurate to understand firm financing. Indeed, in practice, most firms are not liquidated as their debt matures. Rather, they issue new debt and keep operating as long as they can meet their contractual payment obligations. Bankruptcy usually takes place whenever firms default on promised payments on their debt. At any point in time, equity holders can decide whether they want the firm to make the promised payments or default and trigger bankruptcy. Thus, bankruptcy is a decision made endogenously by equity holders.

Alexandre Ziegler

4. Junior Debt

Abstract

A common provision in bond contracts is the subordination of the claims of one class of debt holders (called the junior bonds) to those of a second class (called the senior bonds). Under such provisions, at the maturity of the bonds or at the time of bankruptcy, payments can be made to the junior bond holders only if the full promised payment to the senior debt holders has been made. The aim of such provisions is to protect senior creditors against the issue of new debt.¹ Black and Cox [9] provided an explicit valuation formula for two classes of discount bonds of different seniority. Their analysis showed that subordination indeed achieves its anticipated effect of giving the senior bonds a larger value than they would have if they were the corresponding fraction of an undifferentiated bond issue. Furthermore, they established that unlike the senior debt, the value of the junior debt can be an increasing function of the riskiness of the firm’s assets, suggesting that the bondholders as a group may have conflicting interests with respect to changes in the riskiness of the firm’s investment policy.

Alexandre Ziegler

5. Bank Runs

Abstract

Bank Runs are one of the most striking and puzzling phenomena in banking history. Calomiris [15] reports that banking crises in ancient Greece and Rome date from at least the 4th century B.C., as do government interventions to alleviate them. Schwartz [79] notes that although runs do occur, bank failures are far more common than bank runs and that bank runs are rarely contagious.

Alexandre Ziegler

6. Deposit Insurance

Abstract

The analysis in Chap. 5 reveals that the possibility of bank runs induces bank shareholders to prefer investments in low-risk assets and to provide the bank with enough capital in order to reduce the probability of runs occurring. A natural question that arises is whether or not the bank can prevent runs by another means than providing large amounts of capital. This chapter analyzes one of these possibilities: deposit insurance.

Alexandre Ziegler

7. Summary and Conclusion

Abstract

In recent years, game theory has faced methodological problems in handling uncertainty and timing decisions in dynamic models. This book presents a method particularly suited for the analysis of these kind of situations, the game theory analysis of options.

Alexandre Ziegler

Backmatter

Titel: A Game Theory Analysis of Options
verfasst von: Professor Alexandre Ziegler
Verlag: Springer Berlin Heidelberg
Electronic ISBN: 978-3-540-24690-9
Print ISBN: 978-3-642-05846-2
DOI: https://doi.org/10.1007/978-3-540-24690-9

Springer Professional

Über dieses Buch

Inhaltsverzeichnis

Frontmatter

1. Methodological Issues

2. Credit and Collateral

3. Endogenous Bankruptcy and Capital Structure

4. Junior Debt

5. Bank Runs

6. Deposit Insurance

7. Summary and Conclusion

Backmatter