Hedging residual value risk using derivatives

Abstract

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.Residual value risk, credit risk, credit derivatives, factor modeling, copula