No-fault Default, Chapter 11 Bankruptcy, and Financial Institutions

February 1 2021 | Financial Engineering |
This paper analyzes the costs and benefits of a no-fault-default debt structure as an alternative to the typical bankruptcy process. We show that the deadweight costs of bankruptcy can be avoided or substantially reduced through no-fault-default debt, which permits a relatively seamless transfer of ownership from shareholders to bondholders in certain states of the world. We show that potential costs introduced by this scheme due to risk shifting can be attenuated via convertible debt, and we discuss the relationship of this to bail-in debt and contingent convertible (CoCo) debt for financial institutions. We then explore how, despite the advantages of no-fault-default debt, there may still be a functional role for the bankruptcy process to efficiently allow the renegotiation of labor contracts in certain cases. In sharp contrast to the human-capital-based theories of optimal capital structure in which the renegotiation of labor contract in bankruptcy is a cost associated with leverage, we show that it is a benefit. The normative implication of our analysis is that no-fault-default debt, when combined with specific features of the bankruptcy process, may reduce the deadweight costs associated with bankruptcy. We discuss how an orderly process for transfer of control and a predetermined admissibility of renegotiation of labor contracts can be a useful tool for resolving financial institution failure without harming financial stability.

Financial Science Trends and Perspectives: A Review Article

March 2021 | Financial Engineering, Financial Innovation, Retirement Planning | Article
Robert C. Merton's contributions are current. Regarding the design of retirement plans, in a framework of pension deficient systems, the investigations of Merton (1969) and (1971) on optimal consumption and portfolio rules during and after working life acquire contemporary validity. Likewise, Bodie and Merton (2002) propose the use of derivative products, at the international level, to diversify the risks of pension systems just at the moment when these systems of many underdeveloped and industrialized economies are on the verge of collapse; knowing that several of these systems only provide a meager proportion of the salary. Finally, Merton's theory of rational option pricing is retaken to create synthetic oil pipelines and power plants through the use of contingent claims. This paper aims to review the trends and perspectives in financial science and mathematical finance, within the framework of the pioneering contributions of Robert Cox Merton, highlighting priority areas that offer opportunities for research with social and global impacts.

Annual Review of Financial Economics, Volume 1

2009 | Financial Engineering | Book
Lo, Andrew W. and Robert C. Merton, eds., Annual Review of Financial Economics, Volume 1,  Palo Alto: Annual Reviews, 2009.

Financial Economics. 2nd ed.

2009 | Financial Engineering | Book
Bodie, Zvi, Robert C. Merton, and David L. Cleeton. Financial Economics. 2nd ed. N.J.: Prentice Hall, 2009. (Translated into Korean, Chinese and Hungarian.)

‘Dream Team’ of SEAS Quants Discusses Financial Engineering

Spring 2009 | Financial Engineering | Paper
Columbia University, Engineering News, Spring 2009, p. 8-9.

The Design of Financial Systems: Towards a Synthesis of Function and Structure

March 2005 | Financial Engineering | Paper
Merton, Robert C., and Zvi Bodie. "The Design of Financial Systems: Towards a Synthesis of Function and Structure" Journal of Investment Management 3, no. 1 (First Quarter 2005): 1-23. (Was Harvard Business School Working Paper No. 02-074, 2002.) (Reprinted in Chinese in Journal of Comparative Studies, Issue 17, March 2005.)

Foreword: On Financial Innovation and Economic Growth

Spring 2004 | Financial Engineering | Paper
Merton, Robert C. "Foreword: On Financial Innovation and Economic Growth." Harvard China Review (spring 2004): 2-3.