Research

Working Papers


Knightian Uncertainty and Capital Structure: Theory and Evidence


Abstract

I derive the optimal capital structure of a firm when its manager is ambiguity-averse. My model predicts substantially lower leverage for such firms, in comparison to traditional static trade-off models. I use the 1982 Voluntary Restraint Agreement (VRA) on steel import quotas between the U.S. government and the European Community as an exogenous reduction in Knightian uncertainty faced by firms in the U.S. steel industry. Using a difference-in-difference methodology, I find that when uncertainty is resolved, a median firm in the U.S. steel industry increases its market and book leverage by approximately 12% relative to a matched control firm from another industry. The results are not explained away by changes in traditional risk factors or by a change in expected future profitability.



Knightian Uncertainty and Dynamic Capital Structure 


Abstract

I incorporate ambiguity-averse equity-holders who are uncertain about the distribution of a firm’s assets into the dynamic capital structure model of Leland (1994). My model shows the optimal default threshold increases with Knightian uncertainty, whereas it decreases with risk. When the effect of uncertainty dominates that of risk, a firm optimally defaults earlier than predicted by a traditional dynamic model with risk alone. My ambiguity-augmented model predicts substantially lower leverage ratios, in comparison to the benchmark model of Leland (1994).



Robust Security Design with Uday Rajan


Abstract

We consider the optimal contract between an entrepreneur and investors in a single-period model when both parties have limited liability, are risk-neutral toward cash flow risk, and are ambiguity-averse. Ambiguity aversion is modeled by multiplier preferences for robustness toward model uncertainty, as in Hansen and Sargent (2001). Efficient ambiguity-sharing implies that the first-best contract consists of either convertible debt or levered equity. As is customary, in the second-best contract, moral hazard is alleviated by giving more cash to investors in low cash flow states. Under many settings in our model, the optimal security has an equity-like component in high cash flow states, providing a contrast to the results in Innes (1990).


Work in Progress


A Model of Bank Run with Fragile Belief


    Fire Sale Externality in Financial Network


Master Thesis [Econometrics]


Bayesian Stochastic Volatility Model with non-Gaussian Errors: Master thesis presentation

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Seokwoo Lee,
Mar 24, 2017, 6:04 PM
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Seokwoo Lee,
Jan 20, 2017, 10:36 AM
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Seokwoo Lee,
Aug 7, 2015, 11:53 AM