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

See all articles by Ian A. Cooper

Ian A. Cooper

London Business School

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking

Date Written: Undated

Abstract

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

Cooper, Ian Anthony and Mello, Antonio S., Netting and the Design of Financial Contracts with Default Risk (Undated). London Business School Institute of Finance and Accounting Working Paper 205, Available at SSRN: https://ssrn.com/abstract=7188

Ian Anthony Cooper (Contact Author)

London Business School ( email )

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London, London NW1 4SA
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+44 171 262 5050 (Phone)

Antonio S. Mello

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

975 University Avenue
Madison, WI 53706
United States
608-263-3423 (Phone)
608-265-4195 (Fax)

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