CIRJE-F-532 "Strategic Default Jump as Impulse Control in Continuous Time"
Author Name Nakamura, Hisashi
Date December 2007
Full Paper PDF file
Remarks Revised in February 2008.

This paper presents a new approach for modeling an optimal debt contract in continuous time. It examines a competing contract design in a continuous-time environment with Markov income shocks and costly veri able information. It shows that an optimal contract has the form of a long-term debt contract that permits a debtor's strategic default and debt restructuring. The default is characterized by a recurrent, optimal impulse control beyond default. Numerical examples show that the equilibrium probability of the default is decreasing in the monitoring technology level when the default causes a big wealth loss.