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Dynamic Model of Credit Risk in Relationship Lending: A Game- Theoretic Real Options Approach

  • Takashi Shibata

    (Associate Professor, Tokyo Metropolitan University (E-mail: tshibata@tmu.ac.jp))

  • Tetsuya Yamada

    (Deputy Director and Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: tetsuya.yamada@boj.or.jp))

We develop a dynamic credit risk model for the case in which banks compete to collect their loans from a firm in danger of bankruptcy. We apply a game-theoretic real options approach to investigate banksf optimal strategies. Our model reveals that the bank with the larger loan amount, namely, the main bank, provides an additional loan to support the deteriorating firm when the other bank collects its loan. This suggests that there exists rational forbearance lending by the main bank. Comparative statics show that as the liquidation value is lower, the optimal exit timing for the nonmain bank comes at an earlier stage in the business downturn and the optimal liquidation timing by the main bank is delayed further. As the interest rate of the loan is lower, the optimal exit timing for the non-main bank comes earlier. These analyses are consistent with the forbearance lending and exposure concentration of main banks observed in Japan.

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Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

Volume (Year): 27 (2009)
Issue (Month): 1 (November)
Pages: 195-218

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Handle: RePEc:ime:imemes:v:27:y:2009:i:1:p:195-218
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  1. Weeds, H., 2000. "Strategic Delay in a Real Optimna Model of R&D Competition," The Warwick Economics Research Paper Series (TWERPS) 576, University of Warwick, Department of Economics.
  2. Mella-Barral, Pierre & Perraudin, William, 1997. " Strategic Debt Service," Journal of Finance, American Finance Association, vol. 52(2), pages 531-56, June.
  3. Boot, Arnoud W. A., 2000. "Relationship Banking: What Do We Know?," Journal of Financial Intermediation, Elsevier, vol. 9(1), pages 7-25, January.
  4. Elyasiani, Elyas & Goldberg, Lawrence G., 2004. "Relationship lending: a survey of the literature," Journal of Economics and Business, Elsevier, vol. 56(4), pages 315-330.
  5. Grenadier, Steven R, 1996. " The Strategic Exercise of Options: Development Cascades and Overbuilding in Real Estate Markets," Journal of Finance, American Finance Association, vol. 51(5), pages 1653-79, December.
  6. Baba, Naohiko, 2001. "Optimal Timing in Banks' Write-Off Decisions under the Possible Implementation of a Subsidy Scheme: A Real Options Approach," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, vol. 19(3), pages 113-141, November.
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