20 Pages Posted: 30 Sep 2015
Date Written: September 28, 2015
We propose a new model for the valuation of loan commitments and some of their main features including the MAC (Material Adverse Change) clause. We employ a two-period contingent claim approach. The advantage of this approach is that it is based on rational economic considerations that are utility-free and allow taking into account the option to borrow at market rates if the credit risk of the borrower improves with time. On another side the proposed model allows the lender not to give the loan if the company is bankrupt or even when there is a significant deterioration of its credit risk. As a result the standard loan commitment is broken into three different parts that comprise the loan commitment. Each part can be valued separately by using the standard methods of contingent claims valuation. The results explain the low cost of loan commitments and the economic factors that affect the pricing.
Keywords: loan commitment, MAC clause, contingent claims analysis, Merton model
JEL Classification: E43, E49, G21
Suggested Citation: Suggested Citation