Netting and the Design of Financial Contracts with Default Risk
London Business School Institute of Finance and Accounting Working Paper 205
Posted: 3 Jul 1998
Date Written: Undated
We demonstrate, using a simple model, how netting as a design feature of financial contracts has a major effect on default risk. Under general conditions netting of cash flows within a contract is shown to eliminate all first-order effects of default risk. We state the model as both a "hazard rate" model and a "firm value" model to show the equivalence of these two apparently different approaches. We also discuss how this result would apply to netting between different contracts.
JEL Classification: G10, G20
Suggested Citation: Suggested Citation