Risk and the role of collateral in debt renegotiation
AbstractIn his basic model of debt renegotiation, BESTER  argues that collateral is more effective if high risk projects are financed. This result, however, crucially depends on the definition of risk. Using the second-order stochastic dominance criterion introduced by ROTHSCHILD AND STIGLITZ , we show that it is not a project's high risk, induced by a high probability of default, that makes collateral more effective. Instead it turns out that, given the expected return, the probability of default has no impact on the collateral's effectiveness. Moreover, a higher risk of the project caused by a higher loss given default makes the use of collateral even less effective. --
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Bibliographic InfoPaper provided by University of Tuebingen, Faculty of Economics and Social Sciences in its series University of Tuebingen Working Papers in Economics and Finance with number 16.
Date of creation: 2011
Date of revision:
Debt renegotiation; Collateral; Risk; Stochastic dominance;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-08-09 (All new papers)
- NEP-BAN-2011-08-09 (Banking)
- NEP-PPM-2011-08-09 (Project, Program & Portfolio Management)
- NEP-RMG-2011-08-09 (Risk Management)
- NEP-UPT-2011-08-09 (Utility Models & Prospect Theory)
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