Coinsurance effect

Coinsurance effect

Refers to the fact that the merger of two firms lessens the probability of default on either firm's debt.

Coinsurance Effect

A theory stating that a merger of any two companies renders bankruptcy less likely for the merged company than for the two previously constituted companies. The idea behind the coinsurance effect is that spreading assets and liabilities more widely makes default less likely. Theoretically, the coinsurance effect makes bond issues for the merged company lower-risk than those of the previous companies, driving down bond yields.
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In the fourth section, a simple numerical example involving log utility and uniformly distributed disturbance variables illustrates that the coinsurance effects are not likely to be trivial.