Risk and the Role of Collateral in Debt Renegotiation

12 Pages Posted: 11 Oct 2013

See all articles by Werner Neus

Werner Neus

Universitaet Tuebingen - Department of Banking

Manfred Stadler

University of Tuebingen

Multiple version iconThere are 2 versions of this paper

Date Written: November 2013

Abstract

In his basic model of debt renegotiation, Bester () argues that collateral is more effective if high‐risk projects are financed. This result, however, depends crucially on the definition of risk. Using the second‐order stochastic dominance criterion, introduced by Rothschild and Stiglitz (), we show that a project's high risk, induced by a high probability of default, does not improve the effectiveness of collateral. Instead it turns out that, given the expected return, the probability of default has no impact on the collateral's effectiveness. Moreover, a higher risk of the project caused by a higher loss given default makes the use of collateral even less effective.

Suggested Citation

Neus, Werner and Stadler, Manfred, Risk and the Role of Collateral in Debt Renegotiation (November 2013). Economic Notes, Vol. 42, Issue 3, pp. 273-284, 2013, Available at SSRN: https://ssrn.com/abstract=2338784 or http://dx.doi.org/10.1111/j.1468-0300.2013.12010.x

Werner Neus (Contact Author)

Universitaet Tuebingen - Department of Banking ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Manfred Stadler

University of Tuebingen ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

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