Dynamic Capital Structure Optimization in Volatile Markets: A Simulation-Based Approach to Balancing Debt and Equity Under Uncertainty

• Author(s): Mayokun Oluwabukola Aduwo ; Priscilla Samuel Nwachukwu
• Paper ID: 1710294
• Page: 783-797
• Published Date: 31-08-2019
• Published In: Iconic Research And Engineering Journals
• Publisher: IRE Journals
• e-ISSN: 2456-8880
• Volume/Issue: Volume 3 Issue 2 August-2019

Abstract

Dynamic capital structure optimization has become increasingly critical in volatile markets, where sudden shifts in interest rates, credit spreads, and equity valuations can significantly impact a firm’s cost of capital and financial stability. Traditional static models, which rely on fixed leverage targets, often fail to adapt to rapidly changing market conditions and macroeconomic shocks. This proposes a simulation-based framework that integrates stochastic modeling of market variables with dynamic adjustment strategies to balance debt and equity under uncertainty. Using Monte Carlo simulations and scenario-based stress testing, the model evaluates a range of possible future states for key inputs such as debt cost, equity cost, tax rates, and bankruptcy costs. Dynamic rebalancing rules, triggered by market or firm-specific thresholds, are compared against gradual adjustment strategies to identify leverage policies that minimize the weighted average cost of capital (WACC) while preserving firm value. The framework incorporates both historical market data and forward-looking macroeconomic indicators, enabling capital structure decisions to reflect real-time conditions. Simulation results demonstrate that dynamic optimization strategies outperform static targets in volatile environments, offering greater resilience and adaptability. Sensitivity analysis reveals the extent to which optimal leverage decisions are influenced by interest rate fluctuations, equity risk premium shifts, and changes in economic growth expectations. While the approach provides valuable decision support for corporate financial managers, it is not without limitations, including dependence on data quality, model parameter sensitivity, and computational intensity in high-dimensional simulations. Nevertheless, the findings highlight the strategic advantage of adopting flexible, data-driven capital structure policies that respond proactively to uncertainty. This contributes to the growing body of literature on adaptive financial management and offers a practical roadmap for firms seeking to maintain optimal leverage in unpredictable market conditions.

Keywords

Dynamic, Capital structure, Optimization, Volatile markets, Simulation-based approach

Citations

IRE Journals:
Mayokun Oluwabukola Aduwo , Priscilla Samuel Nwachukwu "Dynamic Capital Structure Optimization in Volatile Markets: A Simulation-Based Approach to Balancing Debt and Equity Under Uncertainty" Iconic Research And Engineering Journals Volume 3 Issue 2 2019 Page 783-797

IEEE:
Mayokun Oluwabukola Aduwo , Priscilla Samuel Nwachukwu "Dynamic Capital Structure Optimization in Volatile Markets: A Simulation-Based Approach to Balancing Debt and Equity Under Uncertainty" Iconic Research And Engineering Journals, 3(2)