Effects of maturity choices on loan‐guarantee portfolios1

Abstract

PurposeThe purpose of this paper is to analyse the effects of the maturities of credit‐enhanced debt contracts on the value of an insurer's loan‐guarantee portfolios.Design/methodology/approachThe paper proposes a contingent‐claims model and uses as measure of credit insurance risk, the market value of the private guarantee, which accounts for projects' and guarantor's specific risks, correlations as well as financial leverage.FindingsThe results indicate that in the case of insuring the debts of two parallel projects with different specific risks, one high‐risk and the other low‐risk, the tradeoff between maturities of the guarantees increases with the projects' expected losses, hence the maturity choice decision is crucial for portfolios subject to high expected losses. For a two sequential projects loan‐guarantee portfolio, the paper finds that, regardless of the order of execution of the projects, it is the maturity of the debt supporting the high‐risk project that drives the risk exposure of the portfolio.Practical implicationsSince the management of portfolios of guarantees is of significant importance to many organizations both domestically and internationally, this paper proposes a simple and tractable model to gauge the impact of maturity choices for loan‐guarantee portfolios.Originality/valueThis is a first attempt at modeling multiple maturities in the context of portfolios of vulnerable loan guarantees.