On the Credit Risk of Secured Loans with Maximum Loan-to-Value Covenants

21 Pages Posted: 27 Oct 2011 Last revised: 7 Aug 2014

See all articles by Fabian Astic

Fabian Astic

Moody's Investors Service

Agnes Tourin

NYU Tandon - Department of Finance and Risk Engineering

Date Written: May 5, 2014

Abstract

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.

Keywords: Credit risk, secured loans, illiquid asset, optimal stochastic control, HJB equation

JEL Classification: C61, G21

Suggested Citation

Astic, Fabian and Tourin, Agnes, On the Credit Risk of Secured Loans with Maximum Loan-to-Value Covenants (May 5, 2014). International Journal of Theoretical and Applied Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1950193 or http://dx.doi.org/10.2139/ssrn.1950193

Fabian Astic

Moody's Investors Service ( email )

99 Church Street
New York, NY 10007
United States

Agnes Tourin (Contact Author)

NYU Tandon - Department of Finance and Risk Engineering ( email )

NY
United States