Prepayment Option and Firm Risk-taking | School of Management and Economics

Topic:	Prepayment Option and Firm Risk-taking
Time&Date:	10:30 am -12:00 pm, June 24, 2025 (Tuesday)
Venue	Room D804, Teaching Complex D Building
Speaker:	Bo Sun University of Virginia
Abstract:	We study the pervasive adoption of prepayment options in debt contracts, a phenomenon that persisted robustly even during periods of near-zero interest rates when traditional hedging motives were substantially attenuated. We develop an agency theoretic framework of debt contracting demonstrating that the option to prepay—representing opportunities to refinance when uncertainty about project quality abates over time—provides ex ante incentives for prudent risk-taking, thereby improving firm value. Leveraging the supervisory Federal Reserve Y-14Q data on individual loan contracts, we document data patterns on the take-up, pricing, and ex post performance of bank loans that are consistent with a disciplining role of prepayment options. These findings suggest that prepayment options may serve as effective substitutes for traditional collateral-based lending by establishing dynamic state-contingent incentives that address moral hazard concerns. Moreover, we identify a strategic complementarity between prepayment options and macroprudential regulation, whereby regulatory measures that enhance the risk sensitivity of loan pricing can amplify the disciplinary effect of prepayment options.
Biography:	Bo Sun is an Associate Professor in the Global Economies and Markets area and currently serves as an Associated Editor of the Journal of Money, Credit and Banking. With a keen interest in evidence-based policymaking, Bo conducts theoretical and empirical research on economic implications of information frictions, especially for contracting design, financial market trading, and real economic activity. Her research has been published in leading academic journals, including the American Economic Review, Journal of Monetary Economics, International Economic Review, Journal of Economic Literature, and American Economic Journal: Microeconomics. Prior to joining Darden, Bo was a Principal Economist at the Federal Reserve Board of Governors. She also served on the faculty at Guanghua School of Management of Peking University from 2011-2014. She holds a Ph.D. in Economics from the University of Virginia and B.A. in Finance from Peking University.