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2018•Annals of Financial EconomicsRequires access

CONCERNING THE SEIZURE OF COLLATERAL IN COLLATERALIZED LOAN MARKETS

Adriano Campos Menezes, Jaime Orrillo

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Abstract

This paper deals with the frictions which arise in the transfer of collateral from borrowers to lenders in case of default in collateralized loans. We propose a simple model of collateralized loans in which the sale of assets (borrowing) is tied to the purchase of a put option written on the collateral whose exercise price is the value of debt made by the borrower who is the holder of the put. Thus, lenders protect themselves against the possibility of not being able to seize the collateral in case of default. We show that this new financial mechanism does not destroy the orderly function of markets. Lastly, a remark on efficiency will be offered.

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What this paper is about

This paper deals with the frictions which arise in the transfer of collateral from borrowers to lenders in case of default in collateralized loans. We propose a simple model of collateralized loans in which the sale of assets (borrowing) is tied to the purchase of a put option written on the collateral whose exercise price is the value of debt made by the borrower who is the holder of the put. Thus, lenders protect themselves against the possibility of not being able to seize the collateral in case of default. We show that this new financial mechanism does not destroy the orderly function of markets. Lastly, a remark on efficiency will be offered.

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Available abstract

This paper deals with the frictions which arise in the transfer of collateral from borrowers to lenders in case of default in collateralized loans. We propose a simple model of collateralized loans in which the sale of assets (borrowing) is tied to the purchase of a put option written on the collateral whose exercise price is the value of debt made by the borrower who is the holder of the put. Thus, lenders protect themselves against the possibility of not being able to seize the collateral in case of default. We show that this new financial mechanism does not destroy the orderly function of markets. Lastly, a remark on efficiency will be offered.

Key concepts: Collateralized debt obligation, Collateral, Debt, Loan, Business, Monetary economics, Value (mathematics), Economics

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