Credit risk analysis with creditor’s option to extend maturities

Abstract

We present a Merton (J Finance, 1974)-type structural model of credit risk in which the borrower firm refinances its debt, there is cost for bankruptcy, and the creditor has an option to extend the date of maturity of debt if the firm defaults. We show that a solution exists in such a model and in that solution the creditor has incentive to extend maturity to avoid bankruptcy cost. We solve the model numerically and argue that such maturity extension option for the creditor can have substantial impact on the debt and stock values of the firm.