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A note on selling distressed loans with bank bailouts: modelling of bank interest margins with default probabilities

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  • Jyh-Horng Lin
  • Jyh-Jiuan Lin
  • Ching-Hui Chang

Abstract

This article extends the framework of Merton (1974) with Vassalou and Xing (2004) to value a troubled but solvent bank's equity by explicitly incorporating distressed assets purchased by the government in an imperfectly competitive loan market. We show that the bank may be willing to take this bailout when the purchased amount is relatively small and the margin is relatively low. However, the bank may be harder to entice even when the unit price of the bailed-out assets subsidized by the government is relatively high. As a consequence, most of the first half of the Troubled Asset Relief Program's money is not used to buy troubled assets (Wilson, 2010).

Suggested Citation

  • Jyh-Horng Lin & Jyh-Jiuan Lin & Ching-Hui Chang, 2012. "A note on selling distressed loans with bank bailouts: modelling of bank interest margins with default probabilities," Applied Economics Letters, Taylor & Francis Journals, vol. 19(7), pages 623-627, May.
    • Handle: RePEc:taf:apeclt:v:19:y:2012:i:7:p:623-627
    DOI: 10.1080/13504851.2011.591724
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    Cited by:

    1. Chang, Chuen-Ping, 2012. "Default probability of a captive credit bank with government capital injections: A capped barrier option approach," Economic Modelling, Elsevier, vol. 29(6), pages 2444-2450.

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