Risk and the Role of Collateral in Debt Renegotiation

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Dateien:
Aufrufstatistik

URI: http://nbn-resolving.de/urn:nbn:de:bsz:21-opus-57385
http://hdl.handle.net/10900/47866
Dokumentart: ResearchPaper
Date: 2011
Source: University of Tübingen Working Papers in Economics and Finance ; 16
Language: English
Faculty: 6 Wirtschafts- und Sozialwissenschaftliche Fakultät
Department: Wirtschaftswissenschaften
DDC Classifikation: 330 - Economics
Keywords: Schulden
Other Keywords:
Debt renegotiation , Collateral , Risk , Stochastic dominance
License: Publishing license excluding print on demand
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Abstract:

In his basic model of debt renegotiation, BESTER [1994] 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 [1970], 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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