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Dynamic Model of Credit Risk in Relationship Lending: A Game- Theoretic Real Options Approach

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Author Info

  • Takashi Shibata

    (Associate Professor, Tokyo Metropolitan University (E-mail: tshibata@tmu.ac.jp))

  • Tetsuya Yamada

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: tetsuya.yamada@boj.or.jp))

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    Abstract

    We develop a dynamic credit risk model for the case in which banks compete to collect their loans from a firm in danger of bankruptcy. We apply a game-theoretic real options approach to investigate banksf optimal strategies. Our model reveals that the bank with the larger loan amount, namely, the main bank, provides an additional loan to support the deteriorating firm when the other bank collects its loan. This suggests that there exists rational forbearance lending by the main bank. Comparative statics show that as the liquidation value is lower, the optimal exit timing for the nonmain bank comes at an earlier stage in the business downturn and the optimal liquidation timing by the main bank is delayed further. As the interest rate of the loan is lower, the optimal exit timing for the non-main bank comes earlier. These analyses are consistent with the forbearance lending and exposure concentration of main banks observed in Japan.

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    Bibliographic Info

    Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

    Volume (Year): 27 (2009)
    Issue (Month): 1 (November)
    Pages: 195-218

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    Handle: RePEc:ime:imemes:v:27:y:2009:i:1:p:195-218

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    Related research

    Keywords: Credit risk; Relationship lending; Real option; Game theory; Concentration risk;

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    1. Helen Weeds, 2002. "Strategic Delay in a Real Options Model of R&D Competition," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 729-747.
    2. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June.
    3. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January.
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