The Double Default Value-of-the-Firm Model

30 Pages Posted: 14 Jun 2016

See all articles by Christian Gourieroux

Christian Gourieroux

University of Toronto - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); Ecole Nationale de la Statistique et de l'Administration Economique (ENSAE); National Bureau of Economic Research (NBER)

Alain Monfort

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST); National Bureau of Economic Research (NBER); Maastricht University

Date Written: May 03, 2016

Abstract

In the new Basel Accord, banks have the possibility to consider the double default effect of a guaranteed exposure, which is when both the obligor and the guarantor fail to meet their obligations. This question is currently taken into account by a multivariate value-of-the-firm model, with increased asset correlations between the obligor and the guarantor, in order to capture the additional link created by the guarantee. Such an approach is misleading, since the obligor and guarantor are treated in a symmetric way, whereas the link between obligor and guarantor is clearly asymmetric. Moreover, their joint default involves an over-the-counter price of the guarantee, whose existence and uniqueness have to be analyzed. The aim of our paper is to specify this link in detail, to discuss how it depends on the type of guarantee and the seniorities of the components of the debts, and to deduce its implications in terms of risk management.

Keywords: default, vulnerable option, counterparty credit risk, counterparty valuation adjustment, value of firm

Suggested Citation

Gourieroux, Christian and Monfort, Alain, The Double Default Value-of-the-Firm Model (May 03, 2016). Journal of Credit Risk, Vol. 12, No. 2, 2016. Available at SSRN: https://ssrn.com/abstract=2794965

Christian Gourieroux

University of Toronto - Department of Economics ( email )

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Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

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Ecole Nationale de la Statistique et de l'Administration Economique (ENSAE) ( email )

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National Bureau of Economic Research (NBER)

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Alain Monfort (Contact Author)

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

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Malakoff Cedex, 1 92245
France
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+33 1 4117 6046 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Maastricht University

P.O. Box 616
Maastricht, 6200MD
Netherlands

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