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The Liquidity Regimes and the Prepayment Option of a Corporate Loan in the Finite Horizon Case

Author

Listed:
  • Timothee Papin

    (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique, BNP Paribas CIB Ressource Portfolio Management)

  • Gabriel Turinici

    (IUF - Institut universitaire de France - M.E.N.E.S.R. - Ministère de l'Education nationale, de l’Enseignement supérieur et de la Recherche, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

Abstract

We investigate the prepayment option related to a corporate loan. The default intensity of the firm is supposed to follow a Cox-Ingersoll-Ross (CIR) process and the short interest rate is assumed constant. A liquidity term that represents the funding costs of the bank is introduced and modeled as a continuous time discrete state Markov jump process. The prepayment option is an American option with the payoff being an implicit function of the parameters of the problem. We give a verification result that allows to compute the price of the option. Numerical results are completely consistent with the theory; it is seen that the exercise domain may entirely disappear during such a liquidity crisis meaning that it is not optimal for the borrower to prepay. The method allows to quantify and interpret these findings.

Suggested Citation

  • Timothee Papin & Gabriel Turinici, 2015. "The Liquidity Regimes and the Prepayment Option of a Corporate Loan in the Finite Horizon Case," Post-Print hal-01073598, HAL.
    • Handle: RePEc:hal:journl:hal-01073598
    DOI: 10.1142/S2010493615500026
    Note: View the original document on HAL open archive server: https://hal.science/hal-01073598v2
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