This Paper studies the optimal policies of borrowers (firms or individuals) who may default subject to default costs, and analyses the asset pricing implications. Borrowers defaulting under adverse economic conditions may, despite incurring default costs, emerge as wealthier than non-borrowers...

Portfolio theory must address the fact that, in reality, portfolio managers are evaluated relative to a benchmark, and therefore adopt risk management practices to account for the benchmark performance. We capture this risk management consideration by allowing a prespecified shortfall from a...