On the Credit Risk of Secured Loans
NYU Poly- Department of Finance and Risk Engineering
affiliation not provided to SSRN
October 26, 2011
We propose a framework for analyzing the credit risk of secured loans under historical probability. We assume that the collateral cannot be liquidated immediately. Closed-form solutions for the expected loss are obtained for non-revolving loans. In the revolving case, we introduce a minimization problem with a loss function parameterized by a risk reluctance coefficient. We use stochastic control techniques to derive the Partial Integro-Differential Equation satisfied by the value function, and solve it numerically with a finite difference scheme. We exhibit optimal strategies and compare them with the standard LTV-based lending policy.
Number of Pages in PDF File: 20
Keywords: Credit risk, secured loans, illiquid asset, optimal stochastic control, HJB equation
JEL Classification: C61, G21working papers series
Date posted: October 27, 2011
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