The liquidity regimes and the prepayment option of a corporate loan in the finite horizon case
Papin, Timothée; Turinici, Gabriel (2015), The liquidity regimes and the prepayment option of a corporate loan in the finite horizon case, Global Credit Review, 5, 1, p. 19-33. 10.1142/S2010493615500026
TypeArticle accepté pour publication ou publié
External document linkhttps://hal.archives-ouvertes.fr/hal-01073598
Journal nameGlobal Credit Review
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Abstract (EN)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.
Subjects / Keywordsloan prepayment; liquidity regime; American option; Markov modulated dynamics; mortgage option; switching regimes; CIR process; prepayment option; Snell envelope; option pricing
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