Bougias, A., A. Episcopos, and G. Leledakis (2022). The role of asset payouts in the estimation of default barriers.
International Review of Financial Analysis, Vol. 81, No. 102091

Abstract. In the barrier option model of corporate security valuation, the firm’s creditors impose a default-triggering barrier on the firm value to protect their claim. Two disputed issues in the literature are whether the implied default barrier is positive, and whether it is above or below the book value of the firm’s liabilities. We extend the model of Brockman and Turtle (2003, Journal of Financial Economics 67, 511–529) by embedding asset payouts in the valuation of shareholders’ equity. Using a sample of US stocks from the NYSE, AMEX, and NASDAQ exchanges, our paper exploits market and firm information to compute the implied default barrier for thirty 2-digit SIC groups, including industrials and banks. Our results show that the implied default barrier is lower than it is in the received literature, and it can be less than total liabilities, even zero for some firms. The implied physical default probabilities are significantly lower in the presence of payouts, providing a closer fit to the historical corporate default rates, particularly for issuers of speculative-grade bonds.

Bougias, A., A. Episcopos, and G. Leledakis (2022). Valuation of European firms during the Russia-Ukraine war.  Economics Letters, Vol. 218, No. 110750

Abstract. We infer the asset value dynamics of European firms during the Russia-Ukraine war via the structural model of Merton (1974). Using high-frequency stock price data, we find that the war led to lower corporate security prices and higher asset volatility, eventually shifting asset values closer to the default region. On average, the balance sheet of European firms is expected to shrink by 2.05% and their 1-year default probability to increase from 0.32% to 2.12%. Regression analysis on asset and equity returns as well as default probability changes suggests that these effects are stronger for firms with large revenue exposure to Russia.

Bougias, A. and A. Episcopos (2022). Sovereign debt dynamics with serial defaults. Available at SSRN

Abstract. We propose a structural model of sovereign debt valuation that explicitly incorporates the possibility of serial defaults. We derive closed-form stock and sovereign bond prices for a government that can strategically default multiple times on its outstanding debt. Exploiting the information content of the stock and CDS markets, we calibrate the model for a sample of eight serial defaulting countries through a two-stage maximum likelihood procedure. Consistent with the theoretical predictions, serial default risk is an important risk factor of sovereign bonds. Specifically, the serial default premium is on average 60 basis points and explains 15% of the sovereign credit spread. On the other side, serial defaults are not an important risk factor of stock returns, as the former reduce the stock prices by only 20 basis points. Overall, our model resembles the documented stylized facts of serial defaulters and provides a new way of recovering investors' serial default risk exposure from the equity and credit markets.

• Presented at the 11th Financial Engineering and Banking Society National Conference [Slides]

Bougias, A. and A. Episcopos (2022). A theory of weak deposit insurance schemes. 

Abstract. This paper presents a trade-off model of a regulated bank that issues insured deposits under an explicit deposit insurance scheme. The latter is assumed to be weak, since the guarantee fund is exposed to credit risk and is unable to fully mitigate the risk of bank runs. This framework allows us to examine the effect of weak deposit insurance on bank capital regulation and the deposit insurance pricing decision faced by the deposit insurer. We show that minimum capital requirements successfully mitigate any asset substitution and moral hazard problem induced by the shareholders, even in regimes with regulatory capital forbearance or mispriced insurance premia. We further introduce a new measure that we call the reservation price of deposit insurance,  defined as the highest premium that makes deposit insurance irrelevant to the bank. The reservation price specifies an upper bound to the insurance premium that the insurer can charge. In the presence of weak deposit insurance,  this upper bound is significantly low, thus forcing the guarantee fund to levy on aggregate lower assessment rates.

• Presented at the 10th Financial Engineering and Banking Society National Conference