Pricing the credit risk of secured debt and financial leasing

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Abstract

This paper presents closed form solutions to price secured bank loans and financial leases subject to default risk. Secured debt fair credit spreads always increase in the debtor's default probability, whereas financial leasing fair credit spreads may well decrease in the lessee's default probability and even be negative. The reason is that the lessor, unlike the secured lender, can gain from the lessee's default, especially when the leasing contract envisages initial prepayments or the lessee's terminal options to either purchase the leased asset or to extend the lease maturity. This result, which critically depends on contractual and bankruptcy code provisions, can explain some of the empirical evidence and the use of financial leases as an alternative to secured bank lending to finance small, risky and relatively opaque firms.

Original languageEnglish
Pages (from-to)1298-1320
Number of pages23
JournalJournal of Business Finance and Accounting
Volume33
Issue number7-8
DOIs
Publication statusPublished - 2006

Keywords

  • default risk
  • secured debt
  • debt valuation
  • collateral asset
  • leasing valuation
  • leasing options
  • CONTRACTS
  • OPTIONS

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