In Search of a Modigliani–miller Economy

  • Kay Gieseckea, Lisa R. Goldbergb, Kay Giesecke
  • Published 2004

Abstract

The Modigliani–Miller theorem describes conditions under which the value of a firm is independent of its leverage ratio. It is one of the cornerstones of finance. A history of this result along with a modern perspective on its derivation is given in Rubinstein (2003), Journal of Investment Management 1(2). We extend this history by examining the relationship between the Modigliani–Miller theorem and quantitative models of credit risk. In the first part of the paper, we sort out the role of the Modigliani–Miller theorem and Merton’s classical structural model. This material may be familiar to some readers. Subsequently, we explore the relationship between the Modigliani–Miller theorem and I 2, which is a hybrid structural-reduced form model based on incomplete information, Goldberg (2004), Risk 17(1), 515–518. The I 2 model is not consistent with the Modigliani–Miller theorem. It provides a new way to measure the deviation of real markets from the idealized markets in which the Modigliani–Miller theorem holds.

Cite this paper

@inproceedings{Gieseckea2004InSO, title={In Search of a Modigliani–miller Economy}, author={Kay Gieseckea and Lisa R. Goldbergb and Kay Giesecke}, year={2004} }