Pricing of Corporate Loan: Credit Risk and Liquidity cost

Timothée Papin

in Economics Thesis from University Paris Dauphine from Paris Dauphine University

Abstract: This PhD thesis investigates the pricing of a corporate loan according to the credit risk, the liquidity cost and the embedded prepayment option. A loan contract issued by a bank for its corporate clients is a financial agreement that often comes with more flexibility than a retail loan contract. These options are designed to meet clients’ expectations and can include e.g., a prepayment option (which entitles the client, if he desires so, to pay all or a fraction of its loan earlier than the maturity). The prepayment is the main option and it will be study in this thesis. In order to decide whether the exercise of the option is worthwhile the borrower compares the remaining payments with the outstanding amount of the loan. If the remaining payments exceed the nominal value then it is optimal for the borrower to refinance his debt at a lower rate. For a bank, the prepayment option is essentially a reinvestment risk, i.e. the risk that the borrower decides to repay earlier his/her loan and that the bank cannot reinvest his/her excess of cash in a new loan with same characteristics.The valuation problem of the prepayment option can be modelled as an embedded compound American option on a risky debt owned by the borrower. We choose in this thesis to price a loan and its prepayment option by resolving the associated PDE instead of binomial trees (time-consuming) or Monte Carlo techniques (slow to converge).

Keywords: Liquidité; Prêt corporate; Option américaine; Processus CIR; Chaîne de Markov; Liquidity; Loan prepayment; American option; CIR process; Switching regimes (search for similar items in EconPapers)
JEL-codes: G31 G32 (search for similar items in EconPapers)
Date: 2013 Written 2013
Note: dissertation
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