Valuation of the Prepayment Option of a Perpetual Corporate Loan

Timothee Papin and Gabriel Turinici

Abstract and Applied Analysis, 2013, vol. 2013, 1-13

Abstract:

We investigate in this paper a perpetual prepayment option related to a corporate loan. The default intensity of the firm is supposed to follow a CIR process. We assume that the contractual margin of the loan is defined by the credit quality of the borrower and the liquidity cost that reflects the funding cost of the bank. Two frameworks are discussed: firstly a loan margin without liquidity cost and secondly a multiregime framework with a liquidity cost dependent on the regime. The prepayment option needs specific attention as the payoff itself is an implicit function of the parameters of the problem and of the dynamics. In the unique regime case, we establish quasianalytic formulas for the payoff of the option; in both cases we give a verification result that allows for the computation of the price of the option. Numerical results that implement the findings are also presented and are completely consistent with the theory; it is seen that when liquidity parameters are very different (i.e., when a liquidity crisis occurs) in the high liquidity cost regime, the exercise domain may entirely disappear, meaning that it is not optimal for the borrower to prepay during such a liquidity crisis. The method allows for quantification and interpretation of these findings.

Date: 2013
References: Add references at CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://downloads.hindawi.com/journals/AAA/2013/960789.pdf (application/pdf)
http://downloads.hindawi.com/journals/AAA/2013/960789.xml (text/xml)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hin:jnlaaa:960789

DOI: 10.1155/2013/960789

Access Statistics for this article

More articles in Abstract and Applied Analysis from Hindawi
Bibliographic data for series maintained by Mohamed Abdelhakeem ().