Credit Spreads and Incomplete Information

A new model is presented which produces credit spreads that do not converge to zero for short maturities. Our set-up includes incomplete, i.e., delayed and asymmetric information. When the financial market observes the company's earnings with a delay, the effect on both default policy and credit spreads is negligible, compared to the Leland (1994) model. When information is asymmetrically distributed between the management of the company and the financial market, short credit spreads do not converge to zero. This is result is similar to the Duffie and Lando (2001) model, although our simpler model improves some limitations in their set-up. Short interest rates from our model are used to illustrate effects similar to the dry-up in the interbank market experienced after the summer of 2007.Credit risk; credit spreads; delayed information; asymmetric information

A Model of Deferred Callability in Defaultable Debt

Banks and other financial institutions raise hybrid capital as part of their risk capital. Hybrid capital has no maturity, but, similarily to most corporate debt, includes an embedded issuer's call option. To obtain acceptance as risk capital, the first possible exercise date of the embedded call is contractually deferred by several years, generating a protection period. The existence of this call feature affects the issuer's optimal bankruptcy decision, in addition to the value of debt. We value the call feature as a European option on perpetual defaultable debt. We do this by first modifying the underlying asset process to incorporate a time dependent bankruptcy level before the expiration of the embedded option. We identify a call option on debt as a fixed number of put options using a modified exercise price on a modified asset, which is lognormally distributed, as opposed to the market value of debt. To include the possibility of default before the expiration of the option we apply barrier options results. The formulas are quite general and may be used for valuing both embedded and third-party options. All formulas are developed in the seminal and standard Black-Scholes-Merton model and, thus, standard analytical tools such as 'the greeks', are immediately available.Callable perpetual debt; barrier options

Level dependent annuities: Defaults of multiple degrees

Motivated by the risk of stopped debt coupon payments from a leveraged company in financial distress, we value a level dependent annuity contract where the annuity rate depends on the value of an underlying asset-process. The range of possible values of the asset is divided into a finite number of regions. The annuity rate is constant within each region, but may differ between the regions. We consider both in finite and finite annuities, with or without bankruptcy risk, i.e., bankruptcy occurs if the asset value process hits an absorbing boundary. Such annuities are common in models of debt with credit risk in financial economics. Suspension of debt service under the US Chapter 11 provisions is one well-known real-world example. We present closed-form formulas for the market value of such multi-level annuities contracts when the market value of the underlying asset is assumed to follow a geometric Brownian motion.Multi-level annuity; credit risk; financial distress

Continuous Monitoring: Look before You Leap

We present a model for pricing credit risk protection for a limited liability non-life insurance company. The protection is typically provided by a guaranty fund. In the case of continuous monitoring, i.e., where the market values of the company's assets and liabilities are continuously observable, and where the market values of assets and liabilities follow continuous processes, the regulators can liquidate the insurance company at the instant the market value of its assets equals the market value of its liabilities, implying that the credit protection is worthless. When jumps are included in the claims process, the protection provided by the guaranty fund has a strictly positive market value. We argue that the ability to continuously monitor the equity value of a company can be a new explanation for why jump processes may be important in models of credit risk.Credit risk for non-life insurers; guarantee fund; continuous monitoring; barrier options

On the Pricing of Performance Sensitive Debt

Performance sensitive debt (PSD) contracts link a loan's interest rate to a measure of the borrower's credit relevant performance, e.g., if the borrower becomes less credit worthy, the interest rate increases according to a predetermined schedule. We derive and empirically test a pricing model for PSD contracts and find that interest increasing contracts are priced reflecting a substantial risk of shocks to borrower credit quality. Borrowers using such contracts are of an overall higher credit quality compared to borrowers using interest decreasing contracts. These contracts are priced as if no risk of shocks to borrower credit quality is present.Performance sensitive debt; cash flow ratios; credit ratings

Guaranteed investment contracts: distributed and undistributed excess return

Annual minimum rate of return guarantees are analyzed together with rules for distribution of positive excess return, i.e. investment returns in excess of the guaranteed minimum return. Together with the level of the annual minimum rate of return guarantee both the customer's and the insurer's fractions of the positive excess return are determined so that the market value of the insurer's capital inflow (determined by the fraction of the positive excess return) equals the market value of the insurer's capital outflow (determined by the minimum rate of return guarantee) at the inception of the contract. The analysis is undertaken both with and without a surplus distribution mechanism. The surplus distribution mechanism works through a bonus account that serves as a buffer in the following sense: in ("bad") years when the investment returns are lower than the minimum rate of return guarantee, funds are transferred from the bonus account to the customer's account. In ("good") years when the investment returns are above the minimum rate of return guarantee, a part of the positive excess return is credited to the bonus account. In addition to characterizations of fair combinations of the level of the annual minimum rate of return guarantee and the sharing rules of the positive excess return, our analysis indicates that the presence of a surplus distribution mechanism allows the insurer to offer a much wider menu of contracts to the customer than without a surplus distribution mechanism

Debt relief and growth: A study of Zambia and Tanzania

This paper discusses some issues on how to evaluate the impact of HIPC debt relief in the cases of Tanzania and Zambia using two computable general equilibrium models. Within our relatively simple model framework, we found that the macroeconomic impact of debt relief is modest. One reason for this relatively modest impact is that the annual injection of additional resources relative to current actual debt service is small in both cases, which implies that the impact of debt relief per se would be expected to be modest. However, as illustrated in the case of Tanzania the impact could be considerably higher if additional public investment succeeds to improve private sector productivity. – HIPC ; Zambia ; Tanzania ; CGE-models ; growt

Blood-brain barrier permeability in rats exposed to electromagnetic fields used in wireless communication

iological effects of radio frequency electromagnetic fields (EMF) on the blood-brain barrier (BBB) have been studied in Fischer 344 rats of both sexes. The rats were not anaesthetised during the exposure. All animals were sacrificed by perfusion–fixation of the brains under chloralhydrate anaesthesia after the exposure. The brains were perfused with saline for 3–4 minutes, and thereafter perfusion fixed with 4% formaldehyde for 5–6 minutes. Whole coronal sections of the brains were dehydrated and embedded in paraffin and sectioned at 5 m. Albumin and fibrinogen were demonstrated immunohistochemically and classified as normal versus pathological leakage. In the present investigation we exposed male and female Fischer 344 rats in a Transverse Electromagnetic Transmission line chamber to microwaves of 915 MHz as continuous wave (CW) and pulse-modulated with different pulse power and at various time intervals. The CW-pulse power varied from 0.001 W to 10 W and the exposure time from 2 min to 960 min. In each experiment we exposed 4–6 rats with 2–4 controls randomly placed in excited and non-excited TEM-cells respectively. We have in total investigated 630 exposed rats at various modulation frequencies and 372 controls. The frequency of pathological rats is significantly increased (p < 0:0001) from 62=372 (ratio: 0:170:02) for control rats to 244=630 (ratio: 0:390:03) in all exposed rats. Grouping the exposed animals according to the level of specific absorbed energy (J/kg) give significant difference in all levels above 1.5 J/kg. The exposure was 915 MHz microwaves either pulse modulated (PW) at 217 Hz with 0.57 ms pulse width, at 50 Hz with 6.6 ms pulse width or continuous wave (CW). The frequency of pathological rats (0:17) among controls in the various groups is not significantly different. The frequency of pathological rats was 170=481 (0:350:03) among rats exposed to pulse modulated (PW) and 74=149 (0:500:07) among rats exposed to continuous wave exposure (CW). These results are both highly significantly different to their corresponding controls (p < 0:0001) and the frequency of pathological rats after exposure to pulsed radiation (PW) is significantly less (p < 0:002) than after exposure to continuous radiation (CW)

The red-listed Cetrelia cetrarioides (Parmeliaceae) is confirmed by molecular data in Belarus

The new locality of the Red-listed lichen Cetrelia cetrarioides was discovered in Belovezhskaya Puscha National Park. The occurrence of this species was confirmed by the sequence of the ITS region