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Loan Guarantees: An Option Pricing Theory Perspective

Author

Listed:
  • Fabio Pizzutilo

    (Department of Studi aziendali e giusprivatisitici, University of Bari Aldo Moro , Largo Abbazia S. Scolatica 53, 70123 Bari, Italy,)

  • Francesco Cal

    (Department of Economics Society, Law at University of Urbino Carlo Bo via Vittorio Continelli, n.53, 72017 Ostuni (Br), Italy.)

Abstract

In this paper we analyze security loan guarantees in the light of the option pricing theory. We interpret them as put options on the cash flows of a secured debt. We highlight that the value of the guarantee is always positive before a loan's maturity and it depends on the same factors that determine the value of a financial option. We also analyze their value in the condition of market efficiency and we conclude that the inefficiencies of the financial markets justify their existence. Finally, we focus our attention on public agencies' intervention by offering credit guarantees to private firms.

Suggested Citation

  • Fabio Pizzutilo & Francesco Cal, 2015. "Loan Guarantees: An Option Pricing Theory Perspective," International Journal of Economics and Financial Issues, Econjournals, vol. 5(4), pages 905-909.
    • Handle: RePEc:eco:journ1:2015-04-09
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    References listed on IDEAS

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    4. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    6. Sosin, Howard B, 1980. "On the Valuation of Federal Loan Guarantees to Corporations," Journal of Finance, American Finance Association, vol. 35(5), pages 1209-1221, December.
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    9. Selby, M J P & Franks, J R & Karki, J, 1988. "Loan Guarantees, Wealth Transfers and Incentives to Invest," Journal of Industrial Economics, Wiley Blackwell, vol. 37(1), pages 47-65, September.
    10. Van Son Lai & Michel Gendron, 1994. "On Financial Guarantee Insurance under Stochastic Interest Rates," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 19(2), pages 119-137, December.
    11. Smith, Clifford Jr., 1976. "Option pricing : A review," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 3-51.
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    More about this item

    Keywords

    Loan Guarantee; Option Pricing Theory; Public Guarantee; Guarantee Value;
    All these keywords.

    JEL classification:

    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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