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Hedging residual value risk using derivatives

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  • Sylvain Prado

Abstract

In the leasing industry the lessor faces a risk, at the end of the contract, in not recovering sufficient capital value from resale of the asset. We propose a model to hedge residual value risk using the Gaussian copula methodology. After discussing residual value risk and credit risk modelization, a new derivative product is introduced and analyzed; the Collateralized Residual Values (CRV). The model is applied to an European auto lease portfolio of operating lease contracts pertaining to a major company. Our results indicate that the financial product is easy to customize, and to implement through the contract characteristics and the level of correlation.

Suggested Citation

  • Sylvain Prado, 2009. "Hedging residual value risk using derivatives," EconomiX Working Papers 2009-31, University of Paris Nanterre, EconomiX.
    • Handle: RePEc:drm:wpaper:2009-31
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    References listed on IDEAS

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    1. Davide Meneguzzo & Walter Vecchiato, 2004. "Copula sensitivity in collateralized debt obligations and basket default swaps," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(1), pages 37-70, January.
    2. Hugues Pirotte & Mathias Schmit & Céline Vaessen, 2004. "Credit risk mitigation evidence in auto leases: LGD and residual value risk," Working Papers CEB 04-008.RS, ULB -- Universite Libre de Bruxelles.
    3. Schönbucher, Philipp J., 2000. "Factor Models for Portofolio Credit Risk," Bonn Econ Discussion Papers 16/2001, University of Bonn, Bonn Graduate School of Economics (BGSE).
    4. Mathias Schmit, 2003. "Is Automotive Leasing a Risky Business?," Working Papers CEB 03-009.RS, ULB -- Universite Libre de Bruxelles.
    5. M.Ameziane Lasfer & Mario Levis, 1998. "The Determinants of the Leasing Decision of Small and Large Companies," European Financial Management, European Financial Management Association, vol. 4(2), pages 159-184, July.
    6. Grenadier, Steven R., 1995. "Valuing lease contracts A real-options approach," Journal of Financial Economics, Elsevier, vol. 38(3), pages 297-331, July.
    7. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    8. Schmit, Mathias, 2004. "Credit risk in the leasing industry," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 811-833, April.
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    Cited by:

    1. Sylvain Prado, 2010. "A Family Hitch: Econometrics of the New and the Used Car Markets," Working Papers hal-04140927, HAL.

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    More about this item

    Keywords

    Residual value risk; credit risk; credit derivatives; factor modeling; copula;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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