Loan Portfolio Swaps and Optimal Lending

Jyh-Horng Lin () and Min-Li Yi ()

Review of Quantitative Finance and Accounting, 2005, vol. 24, issue 2, 177-198

Abstract: Theories on loan portfolio swap hedging are based on a portfolio-choice approach. This paper presents an alternative: a firm-theoretic model for bank behavior with loan portfolio swaps. Our paper derives the optimal loan rate and rate-taking loan amount of the bank’s portfolio, and relates them to the market loan rate, counterparty loan rate, swap default risk, capital-to-deposits ratio, and deposit insurance. We find that in the bilateral default risk approach, the comparative static results are generated by four factors: the bank’s risk magnitude about the equity market value, loan composition in the swap contract, the substitution effect in the loan portfolio, and the income effect from the swap transaction. The results imply that changes in the payoff asymmetry in the event of swap default and the bank’s regulatory parameters have a direct effect on the bank’s loan portfolio for lending and swap transactions. Copyright Springer Science + Business Media, Inc. 2005

Keywords: loan portfolio swap; optimal loan rate; capital-to-deposits ratio; deposit insurance (search for similar items in EconPapers)
Date: 2005
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DOI: 10.1007/s11156-005-6336-z

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