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The Flip Side of Financial Synergies: Coinsurance versus Risk Contamination

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  • Albert Banal-Estañol
  • Marco Ottaviani
  • Andrew Winton

Abstract

This paper characterizes when joint financing of two projects through debt increases expected default costs, contrary to conventional wisdom. Separate financing dominates joint financing when risk-contamination losses (associated to the contagious default of a well-performing project that is dragged down by a poorly-performing project) outweigh standard coinsurance gains. Separate financing becomes more attractive than joint financing when the fraction of returns lost under default increases and when projects have lower mean returns, higher variability, more positive correlation, and more negative skewness. These predictions are broadly consistent with existing evidence on conglomerate mergers, spin-offs, project finance, and securitization.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 484.

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Date of creation: May 2013
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Handle: RePEc:bge:wpaper:484

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Keywords: default costs; conglomeration; mergers; spin-offs; project finance; risk contamination; coinsurance;

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