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An overview of the risk-neutral valuation of bank loans

Author

Listed:
  • Tilloca, Danilo

    (Unicredit Holding SpA)

  • Tuzzi, Luciano

    (Unicredit Holding SpA)

Abstract

This paper provides an overview of a new methodology that allows banks to evaluate loans using the risk-neutral approach. In specifically, it illustrates the methodological framework behind the definition of the risk-neutral default probabilities used to estimate the loans credit spreads. These risk-neutral probabilities are calculated using a contingent-claims approach conceptually similar to the Black–Scholes and Merton framework for modeling corporate liabilities. The proposed risk-neutral approach is suitable for producing estimates, in a fair value computation context, that are as close as possible to the “exit price,” as mandated by IFRS 13, with a lower dependency on internal parameters.

Suggested Citation

  • Tilloca, Danilo & Tuzzi, Luciano, 2015. "An overview of the risk-neutral valuation of bank loans," Journal of Financial Perspectives, EY Global FS Institute, vol. 3(2), pages 145-153.
    • Handle: RePEc:ris:jofipe:0079
    as

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    More about this item

    Keywords

    Banking; risk; loans;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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