A closed-form solution to the risk-taking motivation of subordinated debtholders

Abstract

Black and Cox (1976) claim that the value of junior debt is increasing in asset risk when the firm's value is low. We show, using closed-form solution, that the junior debt's value is hump-shaped. This has interesting implications for the market-discipline role of banks' subdebt.Final pre-print of a manuscript accepted for publication in Economic Letters.