Presenter: Piero Gottardi (Essex and CEPR)
Co-author: Alberto Bisin (NYU and NBER), Gian Luca Clementi (NYU Stern and NBER)
Title: Capital Structure and Hedging Demand with Incomplete Markets
Abstract:
We develop a general equilibrium model with production and incomplete markets. As households’ demand for hedging increases, firms issue more debt and destine only part of the greater proceeds to investment – the remainder going to shareholders. How much more debt, depends on the availability of competing risk-sharing instruments. When the capital structure is jointly shaped by hedging demand and agency (asset–substitution), the greater risk induced by asymmetric information has countervailing effects on debt: Debt is reduced to nudge shareholders into choosing lower risk. However, the greater risk in production affects the state prices and calls for more debt.