The Flip Side of Financial Synergies:Coinsurance versus Risk Contamination

Albert Banal-Estanol, Marco Ottaviani and Andrew Winton

No 475, Working Papers from IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University

Abstract: This paper characterizes when joint financing of two projects through debt increases expected default costs, contrary to conventional wisdom. Separate financing dominates joint financing when risk-contamination losses (associated to the contagious default of a well-performing project that is dragged down by a poorly-performing project) outweigh standard coinsurance gains. Separate financing becomes more attractive than joint financing when the fraction of returns lost under default increases and when projects have lower mean returns, higher variability, more positive correlation, and more negative skewness. These predictions are broadly consistent with existing evidence on conglomerate mergers, spin-offs, project finance, and securitization. Journal of Economic Literature Classification Codes: G32, G34. Keywords: Default costs, conglomeration, mergers, spin-offs, project finance, risk contamination, coinsurance.

Date: 2013
New Economics Papers: this item is included in nep-ppm
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Related works:
Working Paper: The Flip Side of Financial Synergies: Coinsurance versus Risk Contamination (2015)
Journal Article: The Flip Side of Financial Synergies: Coinsurance Versus Risk Contamination (2013)
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