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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.

Suggested Citation

  • Sylvain Prado, 2009. "Hedging residual value risk using derivatives," EconomiX Working Papers 2009-31, University of Paris Nanterre, EconomiX.
  • Handle: RePEc:drm:wpaper:2009-31
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    File URL: http://economix.fr/pdf/dt/2009/WP_EcoX_2009-31.pdf
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    References listed on IDEAS

    as
    1. Mathias Schmit, 2003. "Is Automotive Leasing a Risky Business?," Working Papers CEB 03-009.RS, ULB -- Universite Libre de Bruxelles.
    2. Nikolay Nenovsky & S. Statev, 2006. "Introduction," Post-Print halshs-00260898, HAL.
    3. Hugues Pirotte & Mathias Schmit & CĂ©line Vaessen, 2004. "Credit risk mitigation evidence in auto leases: LGD and residual value risk," Working Papers CEB 04-008.RS, ULB -- Universite Libre de Bruxelles.
    4. Philipp J. Schönbucher, 2000. "Factor Models for Portofolio Credit Risk," Bonn Econ Discussion Papers bgse16_2001, University of Bonn, Germany.
    5. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    6. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    7. Schmit, Mathias, 2004. "Credit risk in the leasing industry," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 811-833, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

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

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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