Optimal capital structure and credit spreads under pandemic shocks

We develop a capital structure model under pandemic shocks and highlight the implications of pandemic shocks on valuation of firm's securities, optimal capital structure and credit spreads. We find that equity value is concave when the infected population is small and is convex when the infected population is large. In addition, an increase in volatility of infected population and a decrease in transmission rate will lead firms to choose more debt. Last, credit spreads are negatively correlated with volatility of infected population and positively correlated with transmission rate. Our results are consistent with some empirical findings.(c) 2023 Elsevier B.V. All rights reserved.