Dr Huamao Wang (SMSAS) made a presentation titled Investment for cash flows with mixed-costs guarantee and jump risk, joint with Pengfei Luo and Zhaojun Yang,at the 4th International Conference of Financial Engineering and Banking Society (FEBS), University of Surrey, on 21-23 June 2014.
Abstract: Many SMEs and young entrepreneurs’ accesses to debt financing are subject to low credibility. A mixed-costs guarantee swap with both equity and cash as guarantee fees solves the borrowing constraint, since it provides profits to the insurer during recession and prosperity. With debt and equity financing, a SME invests in a project with the earnings demonstrating leptokurtic returns, upward and downward jumps, which is captured by a double exponential jump diffusion process. Our numerical analysis shows that the jump intensity increases firm option value and delays investment. The guarantee level reduces credit spread until zero. The large marginal cost of debt financing leads to under-investment and low agency cost, while the high guarantee fee results in over-investment and high agency cost. Essentially, the equity-maximizing policy is more risky with over-investment.