MARKET VALUATION OF ILLIQUID DEBT AND IMPLICATIONS FOR CONFLICTS AMONG CREDITORS

We develop a formula for the market value of debt when the borrower's repayment capacity varies stochastically and shortfalls are rolled ove r. The value of a marginal dollar of nominal claim is an S-shaped func tion of the ratio of the repayment capacity to the amount of nominal d ebt. Shifts of this curve are examined in response to changes in the u nderlying parameters. The calculations bring out conflicts of interest among lenders of differing degrees of seniority. Most surprisingly, j unior creditors gain when the loan is rescheduled on terms more favora ble to the debtor.