The amount of leverage of a borrower and the probability of default are positively related, but only after some minimum level of debt.

Question

Quizplus · Accepted Answer

This relationship is known as the "debt overhang" hypothesis and suggests that up to a certain level, increasing leverage can actually decrease the probability of default. However, beyond this threshold, increasing leverage leads to a higher probability of default.

The Amount of Leverage of a Borrower and the Probability