A General Framework for the Valuation of Loan Guarantee Contracts: Plain Vanilla Option Structures vs. Barrier Option Structures
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Abstract
This study proposes a general model within which the values of loan guarantee contracts are analyzed under a framework of multiple guarantors and multiple borrowers. Our model subsumes most of the extant models within the current literature constructed for the purpose of studying loan guarantee contracts. We go on to compare the value of loan guarantee contracts under a plain vanilla option structure against their value under a barrier option structure, and then carry out Monte Carlo simulations to investigate the ways in which the critical parameters of guarantors and borrowers affect the value of loan guarantee contracts, the costs of loan guarantees provided by guarantors, and the probability of default by guarantors. We find that the correlation parameters and capital structures of borrowers and guarantors play important roles in determining the premiums (costs) of loan guarantee contracts, and also find substantial differences between the value (costs) of loan guarantee contracts under both plain vanilla option and barrier option structures.
