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Hedging residual value risk using derivatives

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  • Sylvain Prado

Abstract

Abstract: In the leasing industry the lessor faces a risk, at the end of the contract, in not recovering sufficient capital value from resale of the asset. We propose a model to hedge residual value risk using the Gaussian copula methodology. After discussing residual value risk and credit risk modelization, a new derivative product is introduced and analyzed; the Collateralized Residual Values (CRV). The model is applied to an European auto lease portfolio of operating lease contracts pertaining to a major company. Our results indicate that the financial product is easy to customize, and to implement through the contract characteristics and the level of correlation.

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File URL: http://economix.fr/pdf/dt/2009/WP_EcoX_2009-31.pdf
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Bibliographic Info

Paper provided by University of Paris West - Nanterre la Défense, EconomiX in its series EconomiX Working Papers with number 2009-31.

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Length: 46 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:drm:wpaper:2009-31

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Keywords: Residual value risk; credit risk; credit derivatives; factor modeling; copula;

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  1. Philipp J. Schönbucher, 2000. "Factor Models for Portofolio Credit Risk," Bonn Econ Discussion Papers, University of Bonn, Germany bgse16_2001, University of Bonn, Germany.
  2. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 29(2), pages 449-70, May.
  3. Mathias Schmit, 2005. "Is automotive leasing a risky business?," ULB Institutional Repository 2013/14325, ULB -- Universite Libre de Bruxelles.
  4. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 38(3), pages 297-331, July.
  5. Schmit, Mathias, 2004. "Credit risk in the leasing industry," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(4), pages 811-833, April.
  6. Hugues Pirotte & Mathias Schmit & Céline Vaessen, 2004. "Credit risk mitigation evidence in auto leases: LGD and residual value risk," Working Papers CEB, ULB -- Universite Libre de Bruxelles 04-008.RS, ULB -- Universite Libre de Bruxelles.
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