4-2
(A13)
Corporate Financing
under Ambiguity: A Utility-Free Multiple-Priors Approach
Chang-Chih
Chen
Shih-Chien
University, Taiwan
I build a novel utility-free ambiguity model using the misspecification of
probabilities within good-deal price bounds. In the model managers and outside
investors both feel uncertain about the compensation for invisible idiosyncratic
shock on firm’s partially tradable assets, and infer the magnitude of ambiguity
from arbitragers’ ambition. This ambiguity model is applied to a contingent
claim-based capital structure framework. I find ambiguity aversion makes lenders
hold a most pessimistic belief about the firm’s operating performance as well as
their default decision. This key feature helps address low-leverage puzzle and
credit spread puzzle about corporate debts, and highlights the relevance of
ambiguity preferences in measuring hedging demand and agency conflict beyond
debt service. The comparative statics offer an ambiguity-based explanation for
the link between corporate default/financing policies and exposures to
systematic risk. The magnitude of ambiguity aversion effect in explaining the
patterns observed in the capital structure data is also assessed using a large
cross section of S&P 500 firms.